Report No. 31863-LAC Organization of Eastern Caribbean States Towards a New Agenda for Growth April 7, 2005 Caribbean Country Management Unit Poverty Reduction and Economic Management Unit Latin America and the Caribbean Region Document of the World Bank IDA Industrial Development Authority IFS International Financial Statistics IMF International Monetary Fund INFOTEP Instituto Nacional de Formacidn Tkcnico Profesional IPA InvestmentPromotion Agency JAMPRO Jamaica's Investment Promotion Agency JCCP Jamaica Cluster Competitiveness Programme JSB Jamaica Signature Beats LDC Less-Developed Countries LIAT Leeward Island Air Transport MDGs MillenniumDevelopment Goals MFN Most FavoredNation M I G A Multilateral Investment Guarantee Agency M O U Memorandum o f Understanding NBIA U S National Business Incubator Association NCFMEA National Committee o f Foreign Medical Educationand Accreditation N I S National Insurance Scheme NORAD Norwegian Agency for Development NPL NonPerforming Loan OAS Organization o f American States ODA Official Development Assistance OECD Organization for Economic Cooperation and Development OECS Organization o f Eastern Caribbean States OECS EDU OECS Export Development Unit OERU OECS Education Reform Unit OSPR Office o f Private Sector Relations oss Open Source Software PAHO PanAmerican HealthOrganization PISA Program for International Student Assessment PSIP Public Sector Investment Program REER Real Effective Exchange Rate S A R S Severe Acute Respiratory Syndrome SDT Special and Differential Treatment SEDU Small Enterprise Development Unit SFA Special Framework of Assistance SIGTAS Standard IntegratedGovernment Tax Administration System STEP Small Tourism Enterprise Program TFP Total Factor Productivity TIC Technology InnovationCenter TIMSS Trends inInternational Mathematics and Science Studies UNECLAC UnitedNations Economic Commission for Latin America and the Caribbean UNCTAD UnitedNations Conference on Trade and Development UNDP UnitedNations Development Programme USMLE USMedical Licensing Exam UTECH University o f Technology Jamaica VAT Value Added Tax WDR World Development Report WIBDECO Windward IslandsBanana Development and Exporting Company Limited WITS World IntegratedTrade Solutions WTO World Trade Organization Vice President: Pamela Cox Country Director: Caroline Anstey Sector Director: Ernest0 May Sector Manager: Mauricio Carrizosa Sector Leader: Antonella Bassani Task Team Leader: Camille Nuamah 11 ORGANIZATION OF EASTERNCARIBBEANSTATES TOWARDS A NEWAGENDA FOR GROWTH TABLE OF CONTENTS FOREWORD ................................................................................................................................................ VI ACKNOWLEDGEMENTS ........................................................................................................................ VII EXECUTIVE SUMMARY ........................................................................................................................ vi11 INTRODUCTION ......................................................................................................................................... 1 A. Background .................................................................................................................. 1 B. Objective of the study ................................................................................................... 3 C. Outline of the study ...................................................................................................... 4 CHAPTER 1. THE GROWTH CHALLENGE .................................................................................... 6 A. Growth trends............................................................................................................... 6 B. Sources ofgrowth ......................................................................................................... 7 C. Macroeconomic outcomes and impact....................................................................... 14 D. Current challenges ........................................................... 15 CHAPTER 2. MACROECONOMIC COMPETITIVENESS .......................................................... 18 A. The real exchange rate........................................................................ B. Exportpei$ormance ............................................................................ C. Foreign direct investment.................................................................... CHAPTER 3. THE EXTERNALCLIMATE ..................................................................................... 24 A. Special and differential treatment .............................................................................. 24 B. Emerging trading arrangements ................................................... ...................30 C. Globalization and theprospects for small states .......................... CHAPTER 4. THE INVESTMENT CLIMATE ................................................................................ 37 A. Macroeconomic conditionsfor investment.............................................. B. The role ofpublic investment .................................................................. The investment incentives regime............................................................................... 43 D. C. Investmentpromotion................................................................................. E. The regulatoryframework and administrative efficiency .. CHAPTER 5. SKILLS, WAGES, AND THE LABORMARKET ................................................... 54 A. Skills. education and training...................................................................................... 54 B. Wagesand the labor market........................................................................ CHAPTER 6. TECHNOLOGY,FINANCEAND INFRASTRUCTURE ....................................... 76 A. Firm capacity and technology adoption..................................................................... 76 B. Financefor diverszjkation ......................................................................................... 90 C. Telecoms. energy and transport.................................................. ........................ 96 CHAPTER 7. OPPORTUNITIESFOREXPANDINGEXPORTSOF SERVICES .................... 111 A. B. Tourism............................................................................... c. Offshore education.............................................................. .......................... 121 ICT clusters......................................................................... .......................... 126 D. Health and wellness sewices........................................................................ E. Offshorefinancial services............................................ ........................... 133 REFERENCES .......................................................................................................................................... 135 ... 111 ANNEXES ANNEX 1: GRENADAINVESTMENTCLIMATE SURVEY 143 ANNEX 2: CARIBBEANFOREIGNINVESTORPERCEPTIONSURVEY 145 ANNEX 3: LABORRIGIDITY INDEX 150 ANNEX4: AN EXAMPLEOFDESTINATION-SPECIFIC "EXPORT READINESS" CRITERIA 152 TABLES TABLE1:SELECTED STATISTICS ..............................................,,.,,,...,,,,,.,,.,,,,,,,.,,,,......,.............,......................,.,... 1 TABLE2: SELECTED ECONOMIC INDICATORS, TABLE1.1:SECTORALCOMPOSITIONOFGDP* AND GDPGROWTH,1980-2003................................. 1998-2003 ................................................................... TABLE1.2: TOTALFACTOR PRODUCTIVITY GROWTH (SOLOW RESIDUALS),1980-2000. ..*... TABLE1.3: FACTORDECOMPOSITIONGROWTH OF ............................................................................................... 11 TABLE1.4: PERFORMANCE OFMAJOR TABLE1.5: DEBTSUSTAINABILITY.......................... EXPORTS, 1980-2003 ........................................ ........................................... ..... ~ TABLE2.1:EXPORTPERFORMANCE, 1980-2003................................................................................................... 20 TABLE2.2: TOPTEN*MERCHANDISE EXPORTS ................................................................................................... 21 TABLE2.3: FDIPERFORMANCE............................................................................................................. TABLE3.1: OECS SHAREOFINTRA-CARICOM TRADE,1980-2002.................................................... TABLE3.2: TAIUFF ANDTRADEBARRIERS ........................................................................................................... 28 TABLE3.3: GRENADIANFIRMS' PERCEPTIONSOFLIKELY IMPACT ONSALES..............,....31 OF C S M E AND FTAA TABLE3.4: A C0MPARIS0NOFIRELANDANDTHEOECS........................................................................... TABLE4.1: SECTORALCOMPOSITIONOFPUBLICINVESTMENT, 1995-2001 ................................................ TABLE4.2: TAX RATES ............................................................................................................................... TABLE4.3: THECOSTOFINVESTMENTPROMOTION..................................................................................... TABLE4.4: FIRMRESPONSESTOADMINISTRATIVEPROCEDURESINGRENADA ................................................... 52 TABLE5.1: TIMENEEDEDFILLA VACANCY INGRENADA.............................................................................. TO 56 TABLE5.2: INCREASINGRETURNSTO EDUCATION .............................................................................................. 57 TABLE5.3: SECONDARY ANDTERTIARYEDUCATION........................................... ...................................... 58 TABLE5.4: EDUCATION INDICATORS ............................. TABLE5.5: YOUTH UNEMPLOYMENT ............................. TABLE5.6: TYPES TRAININGINSTITUTIONSUSEDBY FIRMSINGRENADA OF ..................................................... 65 TABLE5.7: SELECTED WAGERATES.................................................................................................................... 68 TABLE5.8: UNEMPLOYMENT .................................................................................................................. 68 TRENDS TABLE5.9: GOVERNMENT EMPLOYMENT WAGES........................................................................................ 70 AND TABLE5.10: INDICES OFLABOR MARKET FLEXIBILITY ............................................................... TABLE6.1: DONOR-FINANCEDPRIVATE SECTORDEVELOPMENT PROJECTSTHEOECS .................................. IN 79 TABLE6.2: NOVELL TABLE6.3: SOURCESOFFINANCEFORFIRMSINGRENADA............................................... CERT~F~CAT~~NCARIBBEAN..................................................................................... 89 INTHE TABLE6.4: A TEXTBOOK CHECKLIST FORFIRMFINANCINGDECISIONS NEW FOR INVESTMENTS .............. .. ,94 ,,,,, , TABLE6.5: SELECTEDTELECOM AND ICTINDICATORS, 2002 ........................... TABLE6.6: IMPACTOFLIBERALIZATION OECS TELECOM TABLE6.7: ELECTRICITYPRODUCTIONANDPRICING........................................ ONTHE SECTOR....... TABLE6.8: TAXIFARES SELECTEDCARIBBEANMARKETS IN ............................................................................ 109 TABLE7.1: TOURISM SEGMENTS, 2000.............................................................................................................. 112 TABLE7.2: INTERNAT~~NAL TOURISTW A L S BYREGIONOFDESTINATION ......................................... TABLE7.3: PUBLICEXPENDITURE TOURISM TABLE7.4: STATISTICS ONTHE usON ................................................... MEDICAL PROFESSION .................................. .................................. 121 TABLE7.5: OFFSHOREMEDICAL TABLE7.6: COMPARISONOFusANDOFFSHORE SCHOOL U S M L EPASS RATES ....................................................................... MEDICAL 124 TABLE7.7: OFFSHOREFINANCIALCENTERS...................................................................................................... SCHOOLS ............................. .................124 133 Figures FIGURE1.1: REALGDP GROWTHINTHEOECS, 1978-2003 ................................................................................. 7 FIGURE1.2: EMPLOYMENT AGRICULTU IN ........................................................................................................... 8 FIGURE1.3: TOTAL, FOREIGNANDDOMESTIC ............................................................. 12 FIGURE1.4: COMPOSITIONOFINVESTMENT, 1977-2003............................................................................ INVESTMENT, 1980-2003 *12 FIGURE 1.5: SOURCES OF FINANCE FORINVESTMENT, 1980-2003 ....................................................................... 13 FIGURE1.6: COMPOSITIONOFINVESTMENT, 1990-2003...................................................................................... 13 FIGURE1.7: FISCAL ACCOUNTS, 1990-2003.....................................,.,.....,..,..,.,.,.,...................,.........,.......,,..,,..,15 iv FIGURE2.1: RERBASEDONDOMESTIC PRICEINDICESONLY. 1990-2003 ........................................................... 19 FIGURE 2.2: RER BASEDON DOMESTIC AND EXTERNAL PRICE INDICES, 1990-2003.................................. FIGURE3.1: VOLUME, VALUEANDPRICESOFBANANA EXPORTS, 1954-2002 ........................................... FIGURE3.2: TRADERECPROCITYIMPROVESEXPORT PERFORMANCE 27 FIGURE3.3: IMPORTANCEOFEXPORT SALES INGRENADA .......................................... ................................................................. ................................... 29 FIGURE4.1: COMPARISONOFINFRASTRUCTURECOSTS ................................................................... 42 FIGURE4.2: GRENADIANINVESTORPERCEPTIONSOFTHE FDIF ~ E W O RK ...................................................... 45 FIGURE4.3: SOURCESOF INFORMATIONFORFOREIGNINVESTORS ...................................................................... 48 FIGURE4.4: FOREIGN INVESTORS' PERCEPTIONSOFTHE INVESTMENT CLIMATE ................................................. 51 FIGURE4.5: STAGESOFE-GOVERNMENT ............................................................................................................. 53 FIGURE5.1: SKILLSCOMPOSITIONOFA SAMPLE OFFOREIGNFIRMSINTHECARIBBEAN (%) ............................. 55 FIGURE5.2: MAJOR OBSTACLESTO FEW COMPETITIVENESS INGRENADA ......................................................... 56 FIGURE5.3: TERTIARYEDUCATION:INVESTMENTANDENROLLMENT (2000) ................................ FIGURE5.4: SHARE OFFIRMSOFFERINGFORMALTRAININGINGRENADA................................................ FIGURE5.5: DISTRIBUTION PUBLIC SPENDING ON TRAINING OF .......................... ................................. 65 FIGURE5.6: REMITTANCE FLOWS ... ........................................................................... FIGURE6.1: TYPES OFINNOVATIVE DERTAKENBY FIRMSINGREN FIGURE6.2: MOREC~MPET~T~VE PRESSURE,MOREINNOVATION .................................................. FIGURE6.3: PROVIDINGBUSINESS DEVELOPMENT SERVICES .......... ............................................................ 81 FIGURE6.4: HowFIRMSINGRENADA INNOVATE ............................ ............................................................ 85 FIGURE6.5: DISTRIBUTION BANKING SECTORLOANS ADVANCES BY BORROWER OF AND HOSTS, .................................................................................................................... ................................. 92 FIGURE6.6: INTERNET 2002 98 FIGURE6.7: ELECTRICITYCOSTS....................................................................................................................... 100 FIGURE7.1: INDICES OF PRICE COMPETITIVENESS INTOURISM .......................... .......................................... 113 FIGURE7.2: INTERNATIONAL MEDICAL GRADUATES THE US, 1984-2004..................................................... IN 122 Boxes BOX 1.1: MEASURING INTERPRETINGTOTALFACTOR AND PRODUCTIVITY(TFP) INTHE OECS ......................... 10 BOX 4.1: THEEASTERN CARIBBEAN CENTRALBANK .......................................................................................... 39 BOX 4.2: ATTRACTING INVESTMENT, COSTARICAN-STYLE ............................................ ................................ 46 BOX 4.3: ONE-STOP SHOP, OR ONE-MORE-STOP SHOP? .................................................... ................................ 48 BOX 5.1: HowTHE SKILLS BASEHELPED BOSTON STAYON TOP TO ..................................................................... 55 BOX 5.2: A TALE OFTWO SCHOOLS ...................................................................................................................... 59 BOX 5.3: ACCOMMODATINGTHE TRAININGNEEDS OF THE PRIVATE SECTOR ....................................................... 62 BOX 5.4: SOCIALPROTECTIONREQUIRESMOREBUSINESSREGULATION ............................. ............................ 73 BOX 5.5: RETURNMIGRATIONINIRELAND AND ISRAEL ...................................................... ............................ 74 BOX6.1: THEJAMAICA CLUSTERCOMPETITIVENESS PROGRAMME(JCCP) ........................................................ 82 BOX6.2: JAMAICA'S TECHNOLOGY INNOVATION CENTER(TIC) ............................................................... BOX 6.3: ELECTRICITYCROSS-SUBSIDIESINDOMINICA ............................................................................. BOX 6.4: THECOSTOF PRICECONTROLSINTHE PETROLEUM SECTOR ................................................................ 103 BOX 6.5: DOMINICA'S EXPERIENCEWITH PORTCARGOHANDLINGOPERATIONS 105 BOX 6.6: OPEN SKIES AGREEMENTS ...................................................................................................................... ....................................... 107 BOX 6.7: A BRIEFHISTORYOF LIAT .... ............................................................. ....................................... 108 BOX 6.8: CENTRALAMERICANREGION COOPERATIONINTHE PETROLEUM SECTOR ...................................... 110 BOX 7.1: THESMALL TOURISM ENTERPRISES PROGRAM (STEP) ...................................................................... 118 BOX 7.2: AMERICAN AIRLINES'DATAPROCESSINGOPERATIONINBARBADOS .................................................. 127 BOX 7.3: CALL CENTERSANTIGUA, LIMITED ..................................................................................................... 127 BOX 7.4: HIGHTELECOMCOSTS HINDERTHE SOFTWAREDEVELOPMENTINDUSTRY .......................................... 130 BOX 7.5: PROMOTINGOPEN SOURCESOFTWAREDEVELOPMENTINST LUCIA . ................................................. 130 BOX 7.6: WORLD CLASS WELLNESS FACILITIES INTHE OECS ..................................................................... V FOREWORD This report on 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 of 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, is 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. Deepeningthe bonds o f regionalism will also require considerable political will, but the pay-offs, we believe, interms of economies o f scale and long term improvements ingrowth and competitiveness, will be considerable. As this volume shows, there are also important new opportunities to be seized: inservices such as education and health, in technology, and in tourism. A number of these opportunities are already being explored in parts o f the OECS and we 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 on 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. We 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. We 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 preparedby Camille Nuamah(Team Leader and Sr. Economist). The preparation was undertaken jointly with the team preparing the companion report on 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 to the World Bank, through the Investment Climate and Trade and Integration Trust Fundunder 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 Blom (skills 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 LoganBrenzel (health services). The World 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 World Bank wishes to extend its 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 its 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 inthe preparation o f this report. vii ORGANIZATIONOF EASTERNCARIBBEANSTATES TOWARDS A NEWAGENDA FORGROWTH EXECUTIVESUMMARY 1. The Organization o f Eastern Caribbean States (OECS)' i s at an economic crossroads. A secular slowdown ingrowth, 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) formulation o f a long-term vision that the 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 of 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 on deeper sub-regional integration, i s not only a sine qua non for the member countries to successfully face their development challenges, but that this approach has already been endorsed both by the Governments and people.ofthe OECS: "The rationalefor the establishment of an economic union is anchored in an acceptance of thefact that the development challenges the micro- states of the OECSface as a result of globalization and trade liberalization can only be effectively addressed through the creation of a single economic space whichfacilitates thefree 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. It 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 now 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 inan increasingly competitive global environment. Accelerating growth in the OECS will` largely depend on the sub-region's ability to strengthen its 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 World Bank Group) and three British dependencies: Montsen-at, Anguilla and the British Virgin Islands. In this report, the term "OECS" has been used, generally, to refer to the six independent countries. viii require improving its competitiveness. At the macro level, competitiveness can be defined as an economy's ability to attract the demand for its exports and the investment to supply that demand, all within social norms that result in an improved standard o f living for its citizens. This, in turn, depends on the macro-.and micro-economic policies, regulations and institutions that affect the productivity of the economy's factors o fproductionand 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 US dollar), by mid 2003 the real exchange rate did not appear to be either over- or under-valued with respect to key fundamentals. There is 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 on 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 still 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 on low 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 inthe process o f identifying new exports -both o f goods and services -but these are still 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 on 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 inthe sub-region and Caribbean wide, have played a key role inthis performance. This issue i s further explored inChapter 4. 9. As illustrated in Chapter 3, reliance on 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 sub- region, and its 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 Union (EU), Canada and the U S has allowed the sub-region to stall on 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 to 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 inturnare negatively affecting fiscal performance. Meanwhile, managing the IMF(2004~). i x 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 limits 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 inwhich 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 on integration within the sub- region 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 is 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 one- fifth of exports of goods and services worldwide and halfof annual FDIflows. Under the EPA, the sub-region will receive substantial assistance to mitigate the costs o f transition. H o w the sub- regionuses these resources will 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 on internet gaming, that it can protect the rightso 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 firms to compete. 12. Much has been written about the challenges faced by small states in this 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, on 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 is strategically located at the center o f a large regional market and still 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 on diversification. The acquisition o f knowledge and technology, which are less susceptible to economies o f scale and distance, are key factors intoday'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 with 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 Union (EU) and the world economy. This case study i s presented in Chapter 3. Of note i s the fact that the first step on Ireland's road to reform was a major and rapid fiscal adjustment over three years, which was achieved on 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 this potential will require a host o f general improvements in the business environment, namely strengthening the investment climate (Chapter 4), expanding the skills base (Chapter 5), promoting innovation and technology adoption, and improving teleconnectivity, international transport services and electricity supply (Chapter 6). X 15. As shown inChapter 4, the size and role o f government inthe OECS has a profound impact on the climate for domestic and foreign investment. The government sector in the sub-region is 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 inthe 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 on 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 on 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 incrowding inprivate investment, inlarge 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. Inaddition, the sub-region has further discouraged competition inthe domestic market with the continued use o f price and investment controls. These have combined to distort the playing field among domestic and foreign investors alike. International experience, inparticular in Mauritius and Ireland, suggests that lowering tax rates and concentrating on other means of investment promotion may be more effective that an unwieldy collection o f concessions and controls. 18. To complement the rationalization o f the investment regime, the sub-region will also have to strengthen its approach to investment promotion, which given the past reliance on incentives, remains in its infancy. Little attention has been given to 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 will also improve the general investment climate. Making headway on e-government initiatives i s one way to accomplish these multiple goals. Two key administrative areas cited by firms 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 firms. 19. As discussed inChapter 5, the most critical constraint facing businesses inthe OECS is the limited skills base o f the labor force. In addition, moving to higher-end services will require a larger number o f skilled workers. The shortage o f skills i s the result o f inadequate educational outcomes, and limited tertiary education and training opportunities. The OECS has made remarkable progress inexpanding 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 highyouth unemployment rates which are now creating social problems. Though comparatively high, public expenditures on education inthe 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 inthe governance o f public training institutions to ensure that the skills 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 inGrenada. Tertiary education and training are two areas where expanding the labor market space o f the OECS to 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. To support this, the OECS should ensure that the accreditations and certifications that it supports are internationallyportable. 21. An effectively functioning labor market is a necessary complement to ensure that the expanding supply of skilled labor i s efficiently allocated. Comparatively highwages that appear to be growing faster than productivity, accompanied by persistently highunemployment, suggest that labor markets in the OECS may not be functioning efficiently. Both 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 under- employed with the skills required by growing sectors. Inaddition, public sector reformto reduce crowding out inthe 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 from trade unions and workers inprotected sectors. Successful experiences in Ireland, Barbados and Jamaica with social pacts may thus needto be replicatedinthe 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 to benefit from remittances and return migrants that transfer skills 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 OECSisgoingtopursueaprivatesector-led, export-orientedgrowthstrategy,local the firms accustomed to a protected domestic market will have to improve their capacity to compete xii globally. At the firm level, innovation is the key to building and maintaining competitive advantage. Chapter 6 showcases some examples o f innovative firms that are already changing the landscape o f the business sector in the sub-region (and in the Caribbean) using ICT as a means to 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 on the free movement o f labor, because it will allow firms 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 firms 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 (inexpanding teledensity, competition and cost reduction) and the Directorate o f Civil Aviation (in addressing security issues in the sub-region's airports) provide examples o f how to move forward on 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 sub- region to address these issues. Regarding the expensive and, sometimes, unreliable supply o f electricity - cited as a key problem by many firms -this report finds that the root cause is 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 sub- regional 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 inthe queue to be "certified". Finally, on aviation, the report finds that the sub-region stands to gain from joint negotiation on international airline service, and from formulation on 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 of the OECS, which largely depended on tourism, donor-financed public investment and preferentialmarket 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 sub- region. 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 inview o f the opportunities and constraints facing the sub-region. It 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 on articulating a vision o f the position the OECS hopes to occupy inthe 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 sub- region. 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 on 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 fthe 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 its strategic location and its tourism sector to move into a cluster o f mode 2 type services in education, health and wellness, financial services and entertainment. The articulation of such a strategy and vision i s necessary for effective negotiationintrade arrangements, effective planning of public investment and formulation o fpublic policies and better use o f aid flows. 30. As illustrated in the case on 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 Reduce barriers to trade and improve the mobility of labor and capital by: o Undertaking tax reform to make fiscal space for a reduction in taxes on 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 on international trade; o Phasing out exceptions within the Common External Tariff (CET) and eliminate non- trade barriers including licences and quotas. Gradual reductions intariffs will not only provide a bargaining chip for trade negotiations but also create both the incentive and transition time for firms to reorient their activities toward the external market; o Reducing and reforming the use o f duty concessions. Reducing tariff rates and non- trade barriers will also reduce the need for widespread use o f duty concessions and related costly and cumbersome administration; o Rapidly implementing free movement of labor within the OECS and the CSME. Access to a greater pool o f skills i s a key to raising firm capacity. Wider opportunities for employment withinthe 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 to facilitate service exports. This will not only help professionals from the OECS to market their services overseas, but may encourage service providers, such as training institutions, that benefit from economies o f scale inother countries, to provide services inthe 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. 0 Promote fair competition and a more level playing field in the domestic market by: o Reducingthe burden o f government on the market for skills and investment resources by pursuingfiscal adjustment andpublic sector reform; o Reforming the tax and customs regime to 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 will help to increase competition inthe 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 inthe administration o f registrations, permits and licenses administration; Reforming the public sector wage setting mechanism to align wage increases with 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 of borrowing by reducing administrative bottlenecks to the realization o f collateral; eliminating floor on the savings deposit rate; and encouraging consolidationinthe banking sector as a means to reduce operating costs and spreads; and Formulate a competition policy for the intra-regional airline market. (iii)Buildingnewcapacityinthelaborforce, privatesectorandgovernmentby: Improving efficiency of education spending o Reform teacher training and deployment schemes to make room for an increase innon-wage spending inthe educationsector; 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 loanprograms. Refocus curricula in schools andtraining institutions on labor market needs o Expand skills training in IT, hospitality, non-hotel tourism services, accounting, finance and management; o Target vocational training on linkages with export sectors rather than solely microenterprise skills 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. 0 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 to include non-hotel services. 0 Publicly reward innovation, entrepreneurship and private sector formation of industry clusters xv 0 Improvethe deliveryof public services, inpart through joint sub-regional provision and harmonizedregulations,whereever possible o Reformand 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 Strengthenregulatory 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 CSME 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 well as to streamline the public sector. 31. N o doubt this i s a daunting agenda, both broad and deep. But the transformationenvisaged here i s fundamental for the OECS countries. It will require the concerted effort on the part o f the OECS govemments, including the sub-regional institutions, the private sector and civil society, as well as sustained support from its development partners, over a medium-term horizon. Hence the need for broad-based participationinthe formulation o f the strategic vision. RecommendedShort-Term Priorities 32. Given the limited capacity of the public sector to address all the recommendations at once, the following i s a proposal for some immediatepriorities,which can be addressed over the short term. Fiscal andpublic sector reform 0 Roll out VAT and reformthe investment incentives regime; 0 Initiate public sector reform and refocus the public investment programs; and 0 Remove non-tariff barriers to trade. Raisethe skills base 0 Reformteacher training and deployment schemes; and 0 Accelerate curricula reform in schools and training institutions. Strengthenthe enablingenvironment 0 Updatetourism strategy to target new market segments; 0 Strengthen investment and tourism promotion; and 0 Strengthen and harmonize accreditation for offshore schools. Improve the businessenvironment 0 Streamline customs administration; 0 Address monopoly pricing inremaining telecom segments; xvi 0 Improve oversight of electricity utilities to reduce costs; 0 Formulateand implement an aviation competitionpolicy; and 0 Reformpetroleumpricing mechanisms. xvii INTRODUCTION A. Background 1. This study covers the six independent member states of 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. Kitts and Nevis to 161,000 in St. Lucia. Among the world's micro states4the OECS countries have performed relatively well on a number o f indicators (see Table 1). Per capita incomes range from US$3,400 in St. Vincent and the Grenadines' to US$9,600 in Antigua and Barbuda, and growth has averaged 4.1 percent per annum over the last two decades. Social indicators are also quite good even relative to upper middle income countries, reflecting a history of sustained investments in human and social capital. However, there are indications o f highpoverty with an average headcount ratio o f 29 percent (although most estimates date from the mid 1990s) and highunemployment (most estimates are from the 2001 census), on average 16 percent for the sub-region. TABLE1:SELECTED STATISTICS Pop GDP GDPpc GDPpc Growth Growthpc Poverty Unemp HDI (`000s) (us$m> (US$) (PPP~) (%I (%) (%pop) (%LF) Rank 2003 2003 2003 2002 1980-2003 1980-2003 latest latest 2004 Antigua and Barbuda 79 757 9,629 9,847 4.6 4.2 12 7 55 Dominica 71 255 3,590 5,469 3.2 2.9 33 25 95 Grenada 105 439 4,199 7,178 3.8 2.8 32 13 93 St. Kitts and Nevis 47 370 7,929 12,227 4.7 4.7 31 5 39 St. Lucia 161 693 4,314 5,437 4.3 3.2 25 19 71 St. Vincent and the Grenadines 109 371 3,403 6,549 4.2 3.5 38 21 87 Up midinc 64,706 5,022 10,684 1.o 2.4 .*. 12 82 Micro 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. HumanDevelopment Index rank is out o f 177 countries. Source: World Bank (2004i), UNDP 2002, national poverty assessments and labor force surveys. 2. Consistent with their small economic size, the OECS countries are well 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 sub- regional institutions), which i s similar to other micro states, but higher than other upper middle income countries. OECS investment rates are relatively highat 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 World Bank Group) and three Britishdependencies: Montserrat, Anguilla and the BritishVirgin Islands. In this report, the term "OECS" has beenused, generally, to refer to the six independent countries. Population less than 500,000. Throughout the report, the terms "Antigua", "St. Kitts" and "St. Vincent" refer to Antigua and Barbuda, St. Kitts and Nevis, and St. Vincent and the Grenadines, respectively. Purchasing power parity uses a conversion rate that reflects how many goods local currency buys within the country. 1 has been financed from extemal sources. Despite its 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 Union that administers a quasi-currency board arrangement to support a fixed exchange rate pegged to the U S dollar. TABLE2: SELECTED ECONOMICINDICATORS, 1998-2003 ExternalSector Public Sector Monetary Sector Domestic Govt Fiscal Public Financial Trade FDI ODA Investment savings spending balance debt* depth* Inflation* YoGDP %GDP %GDP %GDP %GDP %GDP %GDP %GDP M2IGDP CPI%ch Antigua and Barbuda 141 6.3 1.6 29 22 29 -7.9 142 80 1.8 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 Grenadines 117 11.9 3.4 32 35 33 -3.5 73 68 0.9 OECS** 124 9.1 3.0 31 21 34 -6.4 113 77 1.7 Micro 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: Of the 45 micro states listed inthe 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 IMFestimates. 3. The OECS was formed in 1981 through the Treaty o f Basseterre, amidst the independence movements o f its 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 on 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 highon the Human Development Index (see Table 1) - as well 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 inthe sub-region, which has, at times, affectedpolicy stability. 5. Despite this generally positive picture, the OECS i s now at an economic crossroad. The region i s experiencing a secular slowdown in growth and radical changes in its 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. More recently, the global economic slowdown, declining preferential access for its 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 inthe 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 well 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 of the domestic markets, the stimulus for renewed growth can only come from taking advantage o f opportunities inthe 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 aDominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines), is to , ~ provide the analytical basis for a strategy to accelerate growth and improve competitiveness in response to the challenges outlined above. The study will 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 inparticular, impending trade arrangements on, inter alia, sources o f growth, comparative and competitive advantage, the domestic private sector, Foreign Direct Investment (FDI), and employment inthe OECS; identify key constraints to, and drivers of, the sub-region's international competitiveness interms o f its ability to attract demand for its exports and the investment needed to translate that demand into economic growth andjob 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 is 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 on this 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" or "St. Kitts 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 civil society, media, political parties and the private sector on the future directions o f development inthe OECS. The report can also provide an opportunity for donors to discuss how best to support such a strategic framework, once formulated, and better harmonize and coordinate their support around its 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 highlevels 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 inthis 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 how the issue o f small scale o f the OECS economies impacts both the constraints that the countries face inintegratinginto the global economy, andthe solutions to those constraints. C. Outlineof the study 11. Chapter 1 focuses on 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. It 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 will have to compete, both in terms o f emerging trade arrangements and as small states. It reviews the experience to date with special and differential treatment, examines the challenges and opportunities in the key trade arrangements in which the OECS may participate - the Caribbean Single Market Economy (CSME), the Free Trade Area o f the Americas and the World Trade Organization - and presents a case study on Ireland as an example o f how one small state, facing very similar initial conditions as the OECS countries, achieved sustained and broad-based growth. Chapter 4 focuses on 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 how they are impacting the ability o f OECS firms to produce efficiently and at competitive costs. Chapter 5 focuses on skills, wages and the labor market and Chapter 6 on finance, infrastructure and technology. A shortage o f appropriate skills has been named as the number one constraint by firms across the sub-region to improving their competitiveness. Chapter 5 reviews both the education and training systems in order to identify how this shortfall may be addressed. Chapter 5 also examines the juxtaposition o f high wages and high unemployment facing the OECS and reviews how the labor market inthe 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 on technology summarizes and reviews the basic characteristics o f firms in the OECS in terms o f their capacity to adopt new technologies and to innovate. It then presents some recent findings on 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 on how adoption o f ICT can help firms inother sectors improve their competitiveness. Inthe section on finance, the report reviews financial intermediationthrough both 4 credit and equity markets in the sub-region. Inthe 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 how small scale affects costs and how these might be overcome. 15. Finally, Chapter 7 presents several case studies on existing and potential service exports from the sub-region - tourism, offshore education, ICTs, offshore finance and health services. 5 CHAPTER 1. THEGROWTHCHALLENGE 1. 1 This chapter examines the growth performance o f the OECS countries over the past three decades, taking a cross-country approach. It 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 Growthhas been relatively strong inthe OECS at an average o f 4.1 percent per year during 1980- 2003-higher than the average for the world, micro states and Caribbean countries. However, this growth performance i s clouded by several factors. First, growth inthe 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 inthe 1980s was inpart 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 inprivate 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-upo f debt inthe OECS countries, to levels that test the limits 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 on 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 inproductivity, the increasedmacro-economic vulnerability and the lack o f a strategy for achieving global competitiveness. Inaddition, 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 ingrowth and market share. Three main policy conclusions arise from the growth analysis. The first 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 inthe OECS countries inthe 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, if economic growth i s to be sustained. A. Growthtrends 1.4 Growth inthe OECS has beenrelatively strongat an average of 4.1 percent per year during 1980-2003 compared with a world' average o f 2.9 percent, a micro statesgaverage 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 of the world in terms of average growth rates during 1980-2003. 195 countries. For the purposes o f this report, micro states are identified as independent countries with populations of less than 500,000 persons. 6 FIGURE1.1: REALGDPGROWTHINTHEOECS, 1978-2003 (%change) 1. 5 The sub-region has experienced a secular slowdown in growth since the early 1990s. Real GDP growth inthe OECS averaged 5.9 percent per year inthe 1980s, 3.3 percent inthe 1990s and 1.4 percent in the new millennium (see Figure 1.1). Decomposing these growth rates into trend and cyclical components usingthe two most common techniques" shows similar patterns o f slowdown from the 1980s to the 1990s for all member states. InAntigua 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 on average stronger in the 1980s compared to the 1970s. The slowdown in the OECS was the sharpest felt inthe broader Caribbean12 duringthis period. B. Sources of 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 with sharp declines inproductivity growth and inpublic investment betweenthe 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 ledto a further contraction inprivate investment due to crowding out. The growing fiscal imbalances associated with the increased public investment have been financed by expensive commercial borrowing - both domestic and external - and resulted in an unsustainably large debt burden. Simultaneously, a deterioration in the external environment causing a contraction inexports and inthe resource balance exacerbated the situation. (i) Sectoralcompositionofgrowth 1. 7 The services sector has been the major impetus for overall growth in the OECS during the last two decades (see Table 1.1), accounting for around three quarters o f the growth in value added during 1980-2003, Key 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 inthe tourism and public investments. IoThe Hodrick-Prescott, and Baxter and King filters. See Kida (2004). St. Lucia has insufficient data for this exercise. '21MF(2005). 7 TABLE 1.1:SECTORALCOMPOSITION OI 3DP"AND GDPGROW -1980-2003 Shares of GDP Average growth rates Contribution to GDP (%I (%) growth (YO) 1980s 1990s 2000s 1980s 1990s 2000s 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 21.0 23.2 8.1 3.7 2.0 1.6 0.8 0.5 Mining & Quarrying 0.7 0.9 0.9 14.6 3.0 0.3 0.1 0.0 0.0 Manufacturing 7.4 6.6 6.3 6.9 1.5 0.9 0.5 0.1 0.1 Electricity & Water 2.9 3.8 4.8 7.4 7.0 3.7 0.2 0.3 0.2 Construction 8.3 9.8 11.1 9.0 4.2 2.1 0.8 0.4 0.2 Services 71.5 76.1 78.8 6.0 3.8 1.5 4.0 2.6 1.0 Services excl. Gov. Serv. 52.8 60.6 63.5 6.6 4.8 1.3 3.6 3.0 0.9 Wholesale & RetailTrade 11.7 12.6 12.0 5.4 3.8 0.2 0.6 0.5 0.0 Hotels & Restaurants 8.2 9.2 8.6 6.9 4.6 1.7 0.6 0.4 0.1 Transport 10.9 11.4 11.1 7.5 3.2 0.9 0.8 0.4 0.1 Communications 4.2 8.6 10.9 14.4 9.8 1.o 0.6 0.8 0.1 Banks & Insurance 6.9 9.3 11.1 8.0 6.5 2.5 0.6 0.6 0.3 Real Estate & Housing 6.7 5.5 5.5 3.O 2.2 2.8 0.2 0.1 0.2 Government Services 18.7 15.5 15.3 4.6 1.9 2.7 0.9 0.3 0.4 Other Services 4.2 4.1 4.2 4.9 4.2 1.8 0.2 0.2 0.1 GDP at factor costs 5.9 3.3 1.4 5.9 3.3 1.4 ~ 1. 8 Throughout the last two decades, production in the OECS has shifted from agriculture to industry and services, but this has been accompaniedby muchmore modest shifts in employment, resultingin rising unemployment. The contributiono f agriculture to GDP declined from 14percent in the 1980s to 7 percent inthe 2000s (see Table 1.1). However, agriculture still accounts for a significant 16 percent o f employment inthe sub-region - over a quarter o f the labor force inDominica in 1999, and one fifth in St. Lucia in 2000. The concentration o f the workforce in this rapidly declining sector has resulted inrisingunemployment (see Table 5.8). Sources: Available labor force surveys and censuses. Data for Antigua and Barbuda is 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 inthe 1990s comparedwith 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. Box 1.1 reviews some o f these data constraints and how they may affect these estimates and their interpretation. The basic conclusion that can be drawn i s that the TFP estimates measure general productivity of the economy (including productivity improvements coming from 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 of capital and labor over the period, the change in productivity growth i s clearly associated with the slowdown from 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 from 4-5 percent per year in the 1980s to around near zero growth inthe 1990s. Antigua and Barbuda, Dominica and Grenada saw declines from 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 two 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 1981-2000 1981-1990 1991-2000 Antigua and Barbuda GDP 4.73 6.14 3.32 Labor 0.42 0.32 0.51 Capital 1.20 1.23 1.18 TFP 3.11 4.59 1.63 Dominica GDP 3.53 5.38 1.68 Labor -0.11 -0.10 -0.12 Capital 0.84 0.98 0.70 TFP 2.80 4.50 1.10 Grenada GDP 4.62 5.57 3.68 Labor 0.32 0.26 0.38 Capital 1.23 1.13 1.34 TFP 3.07 4.18 1.96 St. Kitts and Nevis GDP 4.86 5.47 4.24 Labor -0.02 -0.33 0.29 Capital 1.38 2.04 1.31 TFP 2.45 0.43 2.65 St. Lucia GDP 5.12 7.62 2.61 Labor 1.84 1.82 1.86 Capital 0.90 0.79 1.01 TFP 2.37 5.01 -0.26 St. Vincent and the GrenadinesGDP 4.13 6.07 2.19 Labor 0.56 0.64 0.49 Cauital 1.12 1.02 1.22 TFP 2.44 4.41 0.47 Source: Kida (2004). l3 ereport Solowresiduals as ameasure W of TFP growth - regression estimates and cyclically-adjusted regressions estimates were computed with the same results. 9 Gains in totalfactor 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 TFPgrowth in the OECSwhere 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 OECS over the 1990s. However, there are a number of possible explanations that can be explored. 1. 12 One hypothesis i s that productivity growth in the OECS may be partly based on the transition shifts to more productive sectors. Kida (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 of the transition to services inthe rest of the Caribbean took place inthe 1980s, while this movement slowed significantly inthe 1990s. However, inthe OECS it appearsto have continued at largely the same pace over the two decades. Services accounted for 72 percent of GDP in 1980, 76 percent in1990 and 79percent in2000. 10 1, 13 A second hypothesis is that the shift inthe compositionand financing of investment over the decades resulted in lower productivity of ~ a p i t a l . 'The larger share o f public investment inthe 1980s ~ concentrated in social and transport infrastructure supporting the booming tourism and banana sectors may 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 inthe OECS duringthe 1990s (see Figure 1.5) has been associated with 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, inthe 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 is that an 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 on 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 Ivan has provided a window o f opportunity for investing inmore productive variety o f nutmeg trees. In the OECS, the incidence o f natural disasters was similar inthe 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)Factordecompositionofgrowth 1. 16 The 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 by a sharp reduction in export growth. Table 1.3 examines the factor decomposition o f growth inthe OECS during1980-2003. TABLE1.3: FACTOR DECOMPOSITIONGROWTHOF 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, it 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 inChapter 5). Since 1970, on average a natural disaster occurred once every four and a half year in each of the six OECS countries. Not 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 of 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 On 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 DomInv +FDI -m- Public& Private Domestic Inv Source: World Bank (2004i). 1, 18 The persistently high investment rates in the OECS 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 on low income countries. Inthe early 1980s, public investment accounted for about half o f total investment or 16 percent o f GDP during 1980-90, whereas in the 1990s the private sector drove overall investment. FIGURE1.4: COMPOSITION OFINVESTMENT, 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 by 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 half o f the 1990s. Initially, public investment remained high during the second half o f the 1980s, but eventually declined to around 8 percent o f GDP duringthe first half o f the 1990s. l6Investment rates worldwide averaged 23 percent and those for all developing countries' averaged o f 24.5 percent over the same period. 12 FIGURE SOURCESOFFINANCE 1.5: FORINVESTMENT, 1980-2003 .. 8% 6% 4% 2Yo 0Yo 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 an 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 of 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 1990sbecame sharply negative with a correlationcoefficient of-0.45, FIGURE1.6: COMPOSITION OFINVESTMENT, 1990-2003 FDI O m ~ N m Y r l mn mW mt~ m . ~ m o o~ ~ N m ~ m m m m~ m o o o ~ ~ ~ " P I P I Source: World Bank (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, Inthe face of sharply reduced aid flows, the increases inpublic 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 The slowdown in growth across the decades is mirrored in the performance of the sub- region'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, duringthe 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 inthe 1990s and came to a halt inthe early 2000s, while banana exports contracted inthe 1990s and experienced a significant decline inthe early 2000s. TABLE1.4: PERFORMANCEOFMAJOR EXPORTS, 1980-2003 Tourism Bananas 1980s 1990s 2000s 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 % of GDP 40.0 36.5 29.8 % of GDP 9.7 5.1 1.7 % of exports 60.7 57.9 54.1 % of exports 14.4 7.9 3.O Sources: Caribbean Tourism Organization (2003), West Indies Banana Development and Export Company, and World Bank (2004i) C. Macroeconomic outcomes and impact 1.23 The impact of the declining growth rates combined with the response of expansionary fiscal policies in the OECS 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 inthe 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 in2003. 14 FIGURE FISCAL 1.7: ACCOUNTS,1990-2003 _ _ _ _ _ _ _ _ _ _ _ _ _ _ - - - - - - - D E x p e n d i t u r e s -Revenues 1--------- a -4% %il n .- s* (rl a2 e, 25% 3 g ---6% ," 20% .- x G 15% -8% 9 8 -- 3 8 10% L f .- -10% O 5'/o 0O/O -- -12% z Source: World Bank (2004i) 1.24 Despite the deteriorating macroeconomic situation, the current account balance has remained relatively stable at 12percent o f GDP during 1996-2003 and continues to be financed by sufficient capital inflows to allow steady increases ininternational reserves. More 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 fthe capital account). D. Currentchallenges 1.25 As noted above, the growth performance o f the OECS has beenrelatively 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 how to 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 inthe 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, reducingpoverty 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 its 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 its 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 (still accounting for a significant share o f the labor force), this number could be larger." One o f the key challenges inthis regard will be to raise the skill levels o f the poor and unemployed, as well as l7A t a first glance, it would seem that thesejobs are needed predominantly inthe Windward Islands, but one should note carefully intra-regional migration flows. .For example, Antigua and Barbuda's low unemployment rates have been due to a policy of employer-of-the-last resort pursued by the recent government which has shown itself 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 inthe 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 WorldBank." 1.27 Thefiscal imperative. Regaining fiscal and debt sustainability across the OECS is critical not only to resuming growth, but also to safeguard the Eastern Caribbean Currency Union 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. In2003, 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 is 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 ECCB 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 its target growth rate o f 6 percent, the required primary surplus would fall to 8 percent and the fiscal adjustment to 11percent o f GDP. TABLE1.5: DEBTSUSTAINABILITY Public Average Real Primary surplusrequired Avgprimary Implied debt growth interest to achieve 60% debt-to- surplusideficit fiscal % of GDP 2003 1998-2003 rates GDP by 2008 1998-2003 adjustment Antigua and Barbuda 142 3.0 1.8 14.7 -3.3 18 Dominica 122 -0.4 2.1 15.5 -2.2 18 Grenada 113 4.1 6.6 13.4 -4.0 17 St. Kitts and Nevis 171 2.3 3.8 24.7 -6.5 31 St. Lucia 69 1.o 5.0 4.6 0.4 4 St. Vincent and the Grenadines 73 4.7 4.5 2.5 0.4 2 OECS 113 2.6 4.0 12.2 -2.3 14 Source: IMF and World Bank staff estimates. 1.29 It 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 runninga primary surplus inthe order o f 8.5 percent o f GDP over the last decade (1991-2003) inorder to reduce its public debt that stands at 142 percent o f GDP. Such a sustained tight fiscal policy has in turn contributed to a contraction ingrowth 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 its impact on growth. World Bank (2003c, 2003e, 2004f, 2004g, 2004h, forthcoming) and ongoing work on a Caribbean Social Protection Strategy. l9The benchmark of 60 percent o f GDP may be too high for the mediumterm 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 inrevenues, 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 World Bank Analyses of Fiscal Issues for most of the OECS countries2' suggests that the adjustment should be focused on the expenditure side, inpart because tax rates inthe OECS are already high- corporate tax rates average 34 percent across the sub-region - and because unfettered increases inboth 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 World 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 from civil services' reform which may aggravate the already difficult unemployment situation and thus needs to be undertakentogether with efforts to encourage private sector activity. Public investment would also need to be selectively prioritized toward growth supporting interventions, its efficiency improved and its financing coming mainly from grants and concessional loans. 1.31 At the same time, there is scope for increasing the efficiency of revenue mobilization that in turn can positively affect growth. Widespread use of concessions has narrowedthe tax base and created distortions in the economy, while reducing revenue intake. Attention to tax policy i s also warranted on 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 intax administration. Recent work by the IMF and a sub-regional Tax Reform and Administration Commission(2004) presents a program of reform measures, includingthe 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 on imports for both domestic consumptionand investment. Inthe 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. Onaverage, 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 of portfolio inflows and growing net outflows by commercial banks as they offshore excess liquidity. 1, 33 The sub-region now faces several risks to its external sustainability, including the possibility of rising interest charges on 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 its 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 behindand outside o fthe world economy onwhich it depends so heavily, 2oWorld Bank (2003e, 2004f, 2004g, 2004h, forthcoming). 17 CHAPTER 2. MACROECONOMIC COMPETITIVENESS 2. 1 As discussed in Chapter 1, accelerating growth in the OECS will largely depend on the sub- region's ability to strengthen its performance inthe global economy, which inturnwill require improving its competitiveness. At the macro level, competitiveness can be defined as an economy's ability to attract the demand for its exports and the investment to supply that demand, all within social norms that result in an improved standard o f living for its citizens. This, inturn, depends on 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 on 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 inFDIinflows to the sub-region. 2. 2 The analysis o f real exchange rate trends shows evidence that, in the latter half 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 still too small to impact macroeconomic performance. In contrast to exports, the OECS has been extremely competitive in attracting foreign investment, with relatively stable flows as a share o f GDP through the last two decades. However, incomparisonto 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 onthe trade and investment climates as well as on the direct factors o f productionrather than on 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 OECS experienced a relatively sharp correction in the real exchange rate, driven by external factors, so that by mid 2003, it did not appear to be either over- or under-valued. The real exchange rate (RER) index measures how a country's international price competitiveness evolves over time with respect to its trading partners and competitors. Real exchange rates are computed by adjusting nominal exchange rates by the relative movements incosts o f production. The latter is proxied by a variety o f indicators each having their own 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) which are computed using RERs relative movements o f domestic and internationalprice 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 (2004~)constructs several alternative measures o f the RER illustrated inFigure 2.1 and Figure 2.2. Two of the three measures that use domestic price indices -the CPIor the GDP deflator - disaggregated into tradables and nontradables appreciated from around 1995 through late 2002 indicatinga growing inward orientation of the regional economy (see Figure 2.1). 18 90 I ~ Note : Increase = appreciation. Source: IMF (2004). 2. 5 The traditional RER fluctuated around its 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 on the unit prices o f export and imports shows a similar pattern but with a much stronger appreciation during the late 1990s and weaker correction through 2003. With respect to the OECS tourism customers - its trading partners - the RER fluctuated steadily around its 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 is pegged) against major currencies. This illustrates that the OECS maintained itsinternationalprice competitivenessthrough most of the 1990s, became increasingly uncompetitivein its non-tourismtrade in the later part of the decade, but hassincebroadlyregainedprice competitivenessas inthe start of the decade. FIGURE 2.2: RERBASEDON DOMESTIC AND EXTERNAL PRICE INDICES, 1990-2003 160 1.. +Traditional REER ........... -0-TourismCustomersRER tREERbasedonCPIandweightedunitpriceofexportsandimports 150............................................................................................................. 140 ........................................................... 130 -.......................................................... 120 J........................................................................................................... / Note : Increase = appreciation. Source: IMF (2004). 2. 6 Inaddition, the IMF(2004) estimates a co-integrating relationshipbetweenthe real exchangerate 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. Its work illustrates that a significant part of the real exchange rate appreciation since 1995 and more recent depreciation could be accounted for by realignment to this equilibrium rate. In addition, given these recent corrections, the FEERinmid2003 appeared to beneither over- nor under-valuedwithrespect to key fundamentals. B. Export performance 2. 7 After strong growth during the 1980s, the OECS experienced relatively weak performance in its 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 on preferential access to i t s main 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 remainedmuchmore 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: World Bank (2004i). 2. 8 During 1980-2003, the OECS experienced a 7 percent average annual growth inexports of goods and services. However, this has deteriorated over time. Growth rates declined from 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, on 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 inmarket share. The OECS share o f Caribbean tourism earnings also declined from 7 percent inthe 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 from 5.6 percent in 1992 to 3.9 percent in 2002. In 2003, however, the sub-region saw its market share rebound to 4.6 percent. Further details are presented inthe case study on tourism inChapter 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 inthe global equity markets, and the increased scrutiny under the OECD's Financial Action Task Force (FATF) in2000 and after the terrorist attacks inthe U.S. on 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 of payments as well as in the national accounts. Currently, the balance of 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 inTravel 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 paidto local workers. Also, the national accounts statistics only capture data on domestic investments of offshore entities. Since these entities are not mandated to keep records on island, acquiring data on their financial operations has been difficult. 2. 12 Merchandise exports which have accounted, on average, for 30 percent of exports of goods and services from the OECS have also seen major deterioration in performance during the 1990s followed by 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 inthe 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 Bananas 39.6 23.0 -13.4 6.9 7.2 85.9 Electrical apparatus 27.8 16.1 9.7 0.5 0.1 99.5 Soap & soap products 12.6 7.3 -6.6 11.5 80.1 8.5 Nutmeg & others spices 10.8 6.3 1.3 0.3 1.3 98.4 Beer 10.6 6.2 14.3 34.4 61.2 4.3 Essential oils 7.0 4.0 6.8 7.5 78.7 13.9 Sugars & sugar confect. 7.3 4.2 -3.1 0.0 0.0 100.0 Paper products 5.6 3.3 -2.3 41.1 54.8 4.1 Arrowroot & other tubers 4.0 2.3 -3.0 18.5 48.2 33.3 Fish. frozen & fresh 3.9 2.3 -2.7 5.4 6.1 88.5 Other products 43.1 25.0 52.0 18.2 29.8 *8Outside the OECS sub-region. Annual average growth rate for the period, 1998-2003. Source: World IntegratedTrade Solution (available at wits.wor1dbank.org) and FTAA Tariff databases. 2. 13 Table 2.2 lists the top 10 merchandise exports from the OECS to CARICOM and the rest o f the world in2003 .2' Of thejust over half o f the exports which go to the rest o fthe world, some 70 percent are directed to markets for which the OECS have preferential access. Within CARICOM, almost half o f these exports are protected by CET rates o f over 10 percent. Of 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 HHIfor individual 21Data 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. 22Based on shares o fthe top 10 products only. 21 countries ranges from 0.50 for St. Kitts to 0.22 for Antigua and Barbuda and Dominica, indicating much less diversification on a country-by-country basis. Seven o f the top 10 exports originate predominantly from one or two 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') andpreferential 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 on preferential access will face major risks in the evolving global environment. For 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 to 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 on how they are able to create competitive advantage inthe new global economy. Box 2.1 shows the uncertain prospects o f electronics assembly in St. Kitts and Nevis. BOX 2.1: ELECTRONICS ASSEMBLY IN ST. MTTS AND NEVIS The largest merchandise export in St. Kitts and Nevis is electronic -cablenetworkfilters and light dimmer switches exported by twofirms. These companies are positioned in a relatively small market segment in the US in which mostproduction has not yet b ced by North American manufacturers. Networkfilters enable cable companiesfacing increased compet US to diyerentiate their promotions across market segments. This requires just-in-time delivery tofacilitate the rapid roll-out of new offerings. Thus, thisfirm 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 ispositioned to serve the growing construction market in the US. Its comparative advantage is being able topurchase inputsfrom around the world, cheaper than they would be available in the US. Both operations arefairly labor intensive - combined, they employ approximately 620persons -andrequireasignificant amountof trainingfor theproduction linestafJ: Proximity tothe USallowsthefirms to source scarce specialized technical skills at short notice rather than install permanent technical stag as would be required in Asia. Thefirms report e small operations, and thefact that the home co to venture veryfar from the US in terms of both language, culture lessfootloose. They contend that the OECS still has a comparati $50-1OOm turnover and requiring a small labor rm in a different market segment has already relocat that, as the Latino communi& in the USgrows, C. Foreign direct investment 2. 16 Incontrast to exports, the OECS appears to be competitive inattracting foreign investment. The sub-region has historically attracted very high levels of FDI relative to its 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 inIntroduction). On average, FDI represents about 27 percent o f gross fixed capital formation in the OECS compared with 15 percent for Latin America. On the UNCTAD index o f FDIperformance, the OECS countries had an average rank o f 20 in2002, with St. Kitts and Nevis ranking3rd after Luxembourg and Chad (see Table 2.3). 23Nutmeg was introduced to Grenada inthe 18th century because of the island`s ideal soil conditions and to create a closer source to Europe than the DutchEast Indies. 24Dominica's soap products started on the basis o f earlier coconut plantations that have since been abandoned. Oils for soap production are now imported. 25Bay oil derives from the leaves o f a non-cultivable tree found solely inDominica. 22 TABLE2.3: FDIPERFORMANCE RankinUNCTAD FDI 1980s 1990s 2000s Performance Index (% share of GDP) 1990 2002 Antigua and Barbuda 11.0 6.4 7.3 2 25 Dominica 4.1 9.3 5.8 7 32 Grenada 3.5 8.6 14.1 11 16 St. Kitts and Nevis 11.3 12.5 22.8 1 3 St. Lucia 11.5 7.9 1.1 4 62 St. Vincent and the Grenadines 3.0 15.0 9.0 20 36 OECS 8.1 9.2 8.8 5 20 Caribbean * (simple avg.) 3.0 4.1 5.2 Caribbean * (weightedavg.) 0.7 2.6 8.0 *OECS shareof Caribbean FDI 20.3 12.3 3.7 not including the OECS Source: UNCTAD, IMFInternational Financial Statistics, World Bank (2004i) 2. 17 Figure 1.3 illustrates that, while cyclical, FDI inflows to the OECS have been relatively stable averaging 8 percent of GDP annually and the volatility for the sub-region as a whole has decreased over time. This stable average however masks significant changes inthe FDI inflows across the OECS countries. Antigua and Barbuda and St. Lucia have seen a steady decline inFDIas a share of GDP since the 198Os,while Grenada and St. Kitts andNevis have seen steady growth. Dominica and St. Vincent and the Grenadines experienced a boom inthe 1990swhich has since moderated (see Table 2.3). 2. 18 While FDIinflows to the OECS remain large and their share of GDP stable, the OECS has lost some ground over time, including to the rest of the Caribbean and the rest of 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 inthe new millennium (8.0 percent). Inaddition, the OECS share o f inflows of FDIto the Caribbean has fallen fromjust over 20 percent inthe 1980s to around 4 percent in the new millennium. In terms o f the rest o f the world, the OECS average ranking on the UNCTAD FDI Performance Index has fallen from 5 in 1990 to 20 in2002, as the sub-region has been overtaken by other countries, which have succeeded inattracting large volumes o f FDIrelative to their GDP. 23 CHAPTER 3. THE EXTERNAL CLIMATE 3. 1 The external trading environment inwhich 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 inwhich the economies and firms 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 its major trading partners - CARICOM, the EuropeanUnion 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 its 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 first at what has been the impact of past SDT on 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 Union and the World Trade Organization (WTO). Finally it 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, UNECLAC (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 patternof 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 inmanufactured 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 is advancing the implementation o f the Caribbean Single Market Economy in preparation for the emerging Free Trade Area o f the Americas, which inturn is expected to subsume the Caribbean's arrangements with Canadaunder 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 its 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 hadpreferences-which attractedres,ourcesto other sectors-not been inplace. 3. 6 It i s important to acknowledge that the OECS banana export volumes did experience rapid and sustained growth, on average 6.1 percent per year, during the Lome Convention period, 1975-93. However, this 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). Ina 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 In1993, 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 its 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 6 0 0 ........................................-z- S! Vucent & the Grenadues '. h c i a s o 0 ......+St 2ls0 0 0 +&nada v - 1 0 0 5 ? s-o I c t o o Source: World Bank (2004i). 3. 8 In1999, under a WTO ruling,the EUmoved to a general ACP quota but with country specific import licenses that continued to favor Windward Island producers. However, despite this continued protection and a temporary recovery inworld prices, the sub-region's banana producers further contracted output to pre-Lome lows (Figure 3.1) reflecting their assessment that with low yields (on average 11 tonnes per hectare and 4 tonnes per worker, compared with 32 and 26 tonnes, respectively for Central 25 American producers)27and higher wages and transport costs, they could not compete inthis sector even under SDT. During 1993-2001, the number o f registeredbanana 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 EUwill move to a tariff-only regime in2006, 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 inOECS 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 in2003, 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 Act (CBERA) on Caribbean and Central American countries finds that the trade arrangement did not result in trade-induced investment-led growth, beyond that which resultedfrom the trade and foreign exchange reforms o f the countries themselves. 3. 11 On the other hand, initial membership in CARICOM has yielded gains for the OECS. The sub- region's share o f intra-CARICOM trade rose from 15 inthe early 1980s to 31 percent inthe early 1990s. However, as the sub-region progressively implemented the CET, that share fell by almost half to 14.6 percent in 2000-02. Meanwhile, EgoumC-Bossogo and Mendis (2002) show that controlling for membership inCARICOM, the OECS itselfhas not beentrade-creating among members. TABLE3.1: OECSSHARE OFINTRA-CARICOMTRADE,1980-2002 tYo) 1980-85 1985-90 1990-95 1995-99 2000-02 Dominica 2.4 5.2 4.8 3.O 2.8 Grenada 3.3 5.5 5.9 1.6 2.9 St. Kitts and Nevis 1.9 3.5 3.4 2.2 1.5 St. Lucia 4.6 8.7 10.3 4.5 4.0 St. Vincent and the Grenadines 3.2 5.4 6 2.1 3.2 OECS (wgtd avg) 15.3 28.3 30.5 16.2 14.6 Source: Egoume-BossogoandMendis (2002) and Caricom Statisticsvarious years. 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 on the sub-region's productive structures and sources o f comparative advantage. As a result, they steered resources to sectors that were not necessarily the most competitive internationally. Over time, this raises the costs o f adjustment, for example, by creating a labor force that i s now ill-suited to new innovations inother sectors. 3. 13 Non-reciprocal protection. The second element o f Special and Differential Treatment is non- reciprocal 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 now- defunct 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 on several fronts. The choice of 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 of 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 on their own 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, infact, 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: TRADERECIPROCITYIMPROVESEXPORT PERFORMANCE 50 45 40 35 30 25 20 15 10 5 0 ExportslGDP Industrial Growth rate of exports/GDP exports Source: Ozden8 Reinhardt (2004) 3. 15 CARZCOM'sArticle 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.31A 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 this 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 its higher tariff rates reserved for agricultural and final manufactured products i s firmly based on 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 inmaximum rates and the prevalent use o f import licenses and quotas shown in Table 3.2 reveal that the OECS still makes active use o f protection as industrial policy. Even within the OECS, there are reports by firms 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 on OECS goods in an effort to raise revenues. 3. 16 Although implementation o f the CET brought weighted average tariffs in the OECS down from 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 (inone case up to 15 percent) on imports intended to mitigate the impact o f falling tariffs on 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 inwhich developed countries provide non-reciprocal market access through tariff preferences to developing countries in a range o f goods. 30 Found inthe Chapter VI1o f the CARICOM Treaty. 31 By exception, reciprocity on these trade barriers is granted only 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: TARIFFANDTRADEBARRIERS Simple Average No. o f products on which import average weighted Maximum quotas exist or import licenses Country Tariff tariff tariff are required CARICOM Non-CARICOM Antigua and Barbuda 6363 9.6 14.3 70 12 51 Dominica 6334 11.9 14.8 165 11 32 Grenada 6317 11.2 15.9 40 0 41 St. Kitts and Nevis 6339 11.5 12.2 70 11 45 St. Lucia 6367 10.1 12.2 95 26 83 StVincent and the Grenadines 6330 10.9 11.5 40 16 42 Sources: UN Trade Analysis and Information System, Finger et a1 (1998), DeRosa (2000) and WTO (2001a, 2001b) and IMFestimates. 3. 17 Inadditionto the hightariffs, import licensingcontinues to bewidely usedby all six countries for trade both within CARICOM 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 on the importation o f selected food items, usually bulk rice, wheat, powderedmilk and/or sugar.32 3. 18 In addition to the authorized exceptions to the CET, a number of OECS countries has applied unilateral trade barriers to OECS and CARICOM imports. For example, in October 2004, CARICOM reported that: 0 St. Kitts and Nevis was applying unauthorized duties to imports o f beer, pasta and aerated beverages from St. Lucia; 0 St. Vincent and the Grenadines was applying an unauthorized import equalization tax on CARICOM rum imports from within CARICOM and maintaining quantitative restrictions on certain agricultural products from Grenada, Jamaica and Trinidad and Tobago; 0 Antigua and Barbuda, Grenada, Dominica, and St. Vincent and the Grenadines were applying discriminatory environmental surcharges or levies on selected CARICOM imports, mainly bottled beverages; and 0 Antigua and Barbuda, St. Lucia and St. Vincent and the Grenadines were maintaining unauthorized importing licences for various CARICOM imports. 3. 19 A notable and widespread case o f non-reciprocal protection is that of beverages, one of the most protected sectors in the sub-region, with tariffs averaging 29 percent33and almost universal import licensing requirements in the individual member countries. Indeed beverages and tobacco are the only categories for which average tariff rates inthe 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 CARICOM Article 56. 32 Governments in the sub-region argue that these public import monopolies are necessary to protect low income consumers from private importers who may emerge as natural monopolies because o f small market size, However, given the low minimum efficient scale and low fixed costs o f trading firms, it is likely that even the domestic markets inthe OECS would support some competition, and at the least could maintain contestability inthis area. 33For beverages and tobacco. 28 These trade barriers may protect both domestic investors and employees inlocal 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 world 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 inone country with only 50 employees benefits from tariffs inthe order to 144percent. 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 of 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 firms continue to focus on the domestic market. Ina recent survey of Grenadian firms conducted for the Diagnostic o f the Investment Climate,34it was found that two thirds of the Grenadian firms serve only the domestic market (see Figure 3.3). Of 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 intourism-related activities. FIGURE3.3: IMPORTANCEOFEXPORT SALES IN GRENADA Export inTotal Sales 0 Source: World Bank (2004e). 3. 21 Longer transition periods and transition assistance. The third element o f SDT 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. UNECLAC (2003) points out that invariably these transition periods are extended giving the impressionto 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 of 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 negotiatingcapacity ininternationaltrade discussions and a substantial share o f aid flows, on propping up an increasinglyuncompetitive 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 for a perpetuation o f Special and Differential Treatment within 34See Annex 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 will be maintained, the sub-region needs to question the longterm benefits o f such treatment. 3. 24 As seen in the above analysis of the banana sector, the advantage conveyed by the special and differential treatment, in particular, preferential access, depends not only on 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 on C B I and CARIBCAN 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 inthe 1980sby low-end data entry firms. 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 CSME 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 Caribbeaninfavor o f regional agreements with reciprocity. B. Emergingtrading arrangements 3. 25 The following section looks at overarching issues3' in the four main emerging trading arrangements inwhich 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) with the European Union, and the World Trade Organization (WTO). These evolving trading arrangements provide opportunities as well as challenges for the OECS. Upcoming liberalization through these arrangements provides a chance for countries to remove distortionary policies, to improve efficiency by retreating from essentially uncompetitive activities, and to 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 of competitiveness that are sustainable. Nonetheless, if managed effectively, the long rungrowth effects will be positive. 3. 26 The CSME. Within CARICOM 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 CSME 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-reciprocalprotection 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 inthe smaller states that the free movement of labor in the CSME will accelerate emigration of 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 its 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 CARICOM countries. With regards to semi and un-skilled workers, wages inthe OECS are infact lower (with the notable exception of Antigua and Barbuda where the government has pursued a full employment policy over the last 35More specific sector issues will be covered inChapter 7. 30 decade36)both nominally in U S dollars, and once adjusted for purchasing power parity. Combined with already higher unemployment rates than its CARICOM 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 interms o f farm and other unskilled workers inthe tourism and construction sectors. 3. 28 Impact on the manufacturing sector. The other major concern with the OECS regarding the CSME i s that their domestic manufacturing sectors will not be able to face competition from larger producers within CARICOM, such as Trinidad and Tobago and Jamaica. Giventhe history o f protection described above, it is likely that a number o f currently protected manufacturers in industries where there are significant economies o f scale will face difficulties in maintaining their current operations. Indeed, thismay only be a preludeto the impact of hrther liberalizationunder the FTAAandWTO. 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 firms, 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 inthe Jamaica situation i s that the signal and incentives were very clear. Inthe face of the depreciation, firms got the message - export or die! 3. 30 Inthe OECS, efforts to maintainLDC treatment evenbehindthe already substantial protectionof the CARICOM CET and to shore up uncompetitive sectors has sent a message to firms that the status quo can somehow be maintained. In a survey o f firms in Grenada, the largest group o f respondents (32 percent for the CSME and 41 percent for the FTAA) expects no impact o f these regional liberalization efforts on their sales (see Table 3.3). As a result, some manufacturing firms which benefit heavily from current levels of protection continue to aim 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 inorder to compete against imports from CARICOM and beyond. TABLE3.3: GRENADIAN FIRMS'PERCEPTIONSOFLIKELYIMPACT OFCSMEAND FTAAONSALES YOof respondents Potential Effect on Sales N o Effect Decrease Increase No response SME Manufacturing 27 38 19 16 Tourism 45 8 35 13 Domestic 32 21 30 18 F Domestic 42 18 21 19 Foreign 36 29 10 26 Manufacturing 34 37 17 14 Tourism 23 3 34 43 Source: World Bank (2004e.). 3. 31 However, there i s already an emerging group o f manufacturers inthe sub-region who are looking increasingly to the international market place. Of the respondents in manufacturing in the Grenada survey, 19 and 17 percent expect an increase in sales coming from the CSME 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 inthe manufacture o f higher-value-added products, like specialty foods and herbal preparations. Some o f these are targeted to ethnic markets 36However, implementation of the recently announced civil service reform program should put downward pressure on wages inthat country. ^. overseas, while others are buildingon the growing cultural reputation o f the Caribbean inNorth American and European markets to reach mainstream consumer. Several have been able to capitalize on 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 this 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 of US$9 trillion, the FTAA would be the largest free trade area inthe 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 on liberalization o f trade inservices.37 Indeed, access to services markets has been one o f the driving factors inthe proliferation o f regionaltrade arrangements, worldwide and liberalization of trade in services has been deepest in North-South trade agreements such as the FTAA (GEP, 2005). Thisprovidesbothan 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. More than half 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 inkey 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 (UNECLAC (2004a). 3. 35 Trade in services under the FTAA i s intended to be consistent with the General Agreement on Trade in Services (GATS) under the WTO. GATS sets out 4 possible modes in which services can be traded between countries: 0 Mode 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 inanother country. 0 Mode 2: ConsumptionAbroad where the service i s consumed inthe territory o f the supplier, such as tourism; Mode 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 Mode 4: Temporary Movement of Persons where the supplier travels to another country to provide a resident there with the service. 3. 36 Given its 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 inthe OECS, the sub-region may want to focus its energies on building competitive advantages necessary to benefit from the growing trade in services worldwide. The sub-region has already proven its potential for Mode 1 (offshore financial services and internet gambling) and Mode 2 service exports (tourism and offshore education), although the performance o f the main services exports has been lagging over the past decade. Inaddition, any further concentration on tourism would only increase the sub-region's vulnerability to external shocks. The challenge facing the OECS will be to revitalizethe 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 of services firms in countries should be covered under the services or by investment chapters. However, these are less relevant for the OECS countries that are likely to concentrate initially on Modes 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 on the sub-region's strategic location, climate, Englishlanguage and cultural similarity to the mainNorthAmerican 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 Union on an Economic Partnership Agreement that will eventually replace the Cotonou Agreement between the EU and the African Caribbean and Pacific (ACP) countries. Negotiations will focus on 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 will 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 will 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 neededtransition. 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, it will be critical for the sub-region to strengthen its aid coordination efforts between the member countries. 3. 39 The WTO and rules-basedinternational trade.Achieving success inservice exports will involve not only addressing supply side constraints at home, but also securing market access overseas. Inturn, market access will depend on 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 rules- based systems that can best protect the rights o f small states. The recent W T O ruling infavor 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 this to the less representative and transparent influence which the OECD's FATF have had in applying its own standards to offshore financial sectors, worldwide. Preferential arrangements, such as those from 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 CARICOM member countries' participation in FTAA, EU-CARICOM and WTO preparations, it has not been delegated negotiating power on behalf o f the member countries. The recent initiative by the OECS to establish a true sub-regional negotiatingbody i s an important one inthis regard. 3.4 1 Behind-the-border rules and regulations such as standards, licensing requirements and competition rules will play an important part inhelping 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 CSME protocols. One notable example i s the regional accreditation of health professionals by the Regional NursingBody and the Caribbean Association o f Medical Councils. Participation inthese 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 on the challenges facing small states in an increasingly integrated global economy, namely, remoteness leading to hightransportation costs; openness resulting inexposure 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 incost 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 performedrelatively well over time on 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 inthe hurricane belt. The sub-region has sustained access to external capital - through FDI, remittances, ODA and commercial borrowing. It has demonstrated resilience to both environmental and external shocks. Cooperationat 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 still has some scope for cooperation to reduce transportation costs. Moreover, for large and small economies alike physical resources are no longer a major constraint on diversification. The acquisition of knowledge and technology which are susceptible to economies o f scale and distance are key factors intoday's economy. 3.44 As such, the outlook for the OECS in the global economy need not be 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 its reform program in 1987, its initial conditions and external performance were quite similar to those in the OECS today (see Table 3.4). 3. 45 The Celtic In1987, the Irisheconomywas plaguedwithhighunemployment 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 of actual contractioninthe 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 correctionand was not thought to be out o f line with its long runequilibrium. 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 from agriculture to low-end manufacturing spurred by cheap labor, its 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 still 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 to 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 highsocial spending at around 6 percent o f GDP on education and 7 percent on health, which produced good social indicators, in particular, education outcomes, but also contributed to the fiscal imbalances. 38Talon andKraemer (1999). 39McCarthy (2001). 34 TABLE 3.4: A COMPARISONOFIRELANDAND THE OECS OECS, today (2003) Irelandin 1987 Irelandin2000 (in%ofGDP, unless otherwise specified) Population (million) 0.6 3.4 3.9 GNI per cap 5,056 7,790 22,970 Growthrate 3.6% 4.6% 11% Inflation ("/o) 1.8% 3.2% -3.2% Agriculture 7.4% 10% 4% 19.8% o f employment 14.7% o f employmentb 7.9% o f employment 29.2% o f exports 4.8 % o f exports Manufacturing 31.8% of merch exports 70.4% o f merch exports Tourism 70% o f exports o f goods and services Government spending 35% 46% 4.3% Public debt 113% 117 % 39% Fiscal balance -5.5% -8.2% 4.7% Primary balance -1.2% -2% 7% Unemployment 16.1% o f work age pop 16.9% o f labor force 4.3% o f labor force Social spending Educ: 7.1% Educ: 5.8 Yo Educ: 4.3 Yo Health: 5.4% Health: 6.6 YO Health: 4.7 % ODA 3%a 2-6% FDI 9.0% 0.3% 24.0% Exports of goods and non- 50.7% 54.6% 98.0% factor services (GNFS) Growth 11% Growth 10% Growth 17% Externalbalance on GNFS 19% 4.4% 13.6% a. not including undisbursed balances o f EUcommitments, b. 1981 Source: World Bank (2004i), McCarthy (2001) 3.47 In1987, Ireland embarkedona major Programfor National Recovery. The turnaround inthe last decade and a half 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. Like all success stories there has been enormous debate on the key determinants o f Ireland's achievements. The following are key lessons gleaned from this debate: 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 on rapid reduction o f the debt stock. Instead, lower financing needs and higher growth rates allowed for a smooth reduction over time. 0 Careful use of the EU structural funds to help sustain infrastructure and social investments, and to reduce the debt burden duringthe 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 EUCourt o f Auditors to have been one o f the more effective users o f this 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 inIreland. Fewer than half of all national schools had piped water and more than half o f all children did not complete secondary schooling. A couple o f decades o f reforms reducedthe dropout rate significantly while simultaneously increasing levels o f tertiary education. Technical colleges and universities were 40Atlas method. 35 refocused on 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 inthe OECD, and i s now ranked as the second best educational system inthe world interms o fresponsiveness to the needs ofacompetitiveeconomy. 0 Establishment of a transparent and favourable corporate tax regime - low 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 on 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 didnot leave any technological `footprint' onthe domestic economy. 0 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 to the reformprogram. 0 Well-coordinated investment promotion efforts with a focus on: (i) targeting flagship FDIthat led to key spillovers to the domestic economy and (ii) strengthening the capacity o f domestic firms. Inthe mid 199Os, the Irish authorities realized that technological spillovers were lagging, with still low levels of IT use by domestic firms 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 firms. 0 An expansive and evolving vision of Ireland's sources of competitive advantage. An unwavering and fonvard-looking focus on external competitiveness has allowed the Irish authorities to stay ahead o f structural changes and put inplace the necessary supports needed. In addition, although Ireland focused on the IT industry as a cluster, it has explored a broad range o f activities that built on its 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 firms, 3.48 Relevancefor the OECS. Most o f the lessons outlined above are broadly relevant for the OECS. However, two are worth discussing further. While participation inthe European Union 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 on macroeconomic, trade and investment policies that the EU institutional framework provided to Ireland. Fullparticipation inthe CSME and FTAA can give a sense o f credibility and permanence not just to trade reforms, but the broader range o fbehind-the-border reforms embodied inthese 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, interms 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 Irishexperiences are: (i) their position role inthe global economy was based in part on existing comparative advantages and in part on competitive advantages that had to be carved out in new areas and (ii) it 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 manufacturingbase and seized the opportunity to provide foreign firms 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 INVESTMENT 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 competitivefirms 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 mostproductive manner. " Porter, M.(1990). The Competitive Advantage o f Nations. 4. 1 As discussed inChapter 1, the sub-region has experienced a secular decline inprivate 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 how they could be addressed. Inaddition, it examines the success of the OECS inattracting record levels of FDIand the likelihood of these trends continuing inthe future. 4. 2 The investment climate can be defined as the "policy, institutional, and behavioral environment, both present and expected, that influences the returns and risks associated with inve~tment".~'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, both domestic and foreign. Numerous studies have demonstrated that a country's macroeconomic conditions, including its 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 on choices o f country location by an investor and how much contribution the investment will 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 its fiscal, monetary and exchange rate policy, are among the most important determinants for both domestic 'and foreign investment. There are three main channels through which macroeconomic conditions in the OECS affect investment: the impact o f macroeconomic stability on firms' investment plans and their assessment o f risk; the effect of the size o f government on the space in which firms have to operate; and the impact o f openness on level o f competition in the market and on the cost and availability o f inputs. The latter has been covered inChapter 3. This section will focus on the first two channels. (i)Macroeconomic stabilityandprivateinvestment 4. 4 As discussed in Chapter 1, the OECS 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 andhas been declining since (see Figure 1.6). 4. 5 This decline inprivate investment coincides with a rapid deteriorationinfiscal 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, resultinginpublic dis-savings, marked increases inpublic 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 in2002. 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 of GDP during 1990-1996, to 35 percent o f GDP in2003. 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 on 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 inthe OECS on average improved to -6 percent o f GDP in 2003. Notably, Dominica's stabilization and adjustment program has resulted in a turnaround inboth 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 inthe presence o f highfiscal deficits and rising public debt, firms will adjust their investment plans downward in anticipation o f increases in future taxation needed to repay this debt. While firms 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 inpublic expenditure reductions. Inthe short run, as wage and capital spending decline, firms may anticipate a further contraction inthe demand for their services, but inthe long run,these reductions will create more space for the private sector inthe economy. 4. 8 The impact of a deterioratingfiscal position and debt overhang has not affected FDIinflows 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 inprivate 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 highand steady levels o f FDIinflows to the OECS were made possible by having a monetary board (see Box 4.1) which ensured monetary and exchange rate stability. 38 Box4.1: THEEASTERN CARIBBEANCENTRALBANK. Caribbean dollar and the US. 4. 10 One reason may be that foreign investors coming to the OECS 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 co- generates its own electricity, desalinates its own drinking water, imports most o f its inputs, transports its guests to and from the airport, and conducts the majority o f its business inU 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 of a concern than conditions inthe external market place. However, as the OECS pursue foreign investment with greater backward linkages, the macroeconomic conditions, both fiscal, real and monetary, will be o f increasing importanceto investors. (ii)Thesizeofgovernment 4. 11 The government sector in the OECS 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. It i s notable that the government services were a leading driver o f growth inthe 1980s and 2000s. 4. 12 Small states have been shown to have large governments for several reasons. The size o f government inthe OECS as measured by spending i s not out o f line with other micro states (see Table 2 inIntroduction), Existing literature on size of government has shown that there is a negative correlation betweenthe share o f government consumption inGDP 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 of the world and, as a result, more volatile, To mitigate this 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, all 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 ina desire to speed development, and on 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 highcost, inefficient public and private enterprises, and ledto a slowdown in The public enterprises usually had difficulties in charging prices that covered costs or in 42Worldwide, measured growth tends to rise when import substitution occurs. However, much of that growth typically reflects deficiencies in national accounting methodology; the new firms' value added is 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 inshieldingitselffromcorruption. 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 on formal sector enterprises and persons inthe 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 on reforms in government that improve its effectiveness and reduce its 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 on 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, inpart due to the political economy that has developed around the role o f the state, over many years o f government intervention. 4. 16 The OECS countries will need to embark on a similar path of public sector reform, if they are to depend on private-sector led growth. The path o f development o f the OECS duringthe last two decades has confirmed the limitations o f public sector-led growth. Given the current fiscal instability and high levels of 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 sub- region. 4. 17 The way forward will depend on addressing the political economy issues head on. As illustrated inthe Ireland case study (Chapter 3), the governments o f the sub-region will need to articulate a strategic vision o f the future, alongside private sector and civil society, and to build a social pact for implementingthe transitionahead. B. The role of public investment 4. 18 Most of the OECS 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 infrastructurehas 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. Inthe longer run, as import substitution possibilities are exhausted, growth becomes more capital intensive and tends to slow. 40 TABLE4.1: SECTORALCOMPOSITION OFPUBLICINVESTMENT, 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 Economic Sectors 30 19 18 17 17 15 16 18 Agriculture 22 15 13 8 10 5 7 I1 Tourism 3 3 4 6 3 8 7 5 Other 5 1 I 3 3 2 1 2 Social Sectors 16 22 19 18 23 29 27 23 General Public Service 5 7 11 10 9 14 12 10 Other 12 8 8 12 13 16 17 13 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 in2002. Source: World Bank ( 2003e, 2004f, 2004g, 2004h, forthcoming). 4.20 One issue to be considered is that a significant fraction of capital budgets has gone toward reconstruction after natural disasters, which have increased in frequency in the 1990s. Inthree out of the seven years presented in Table 4.1, the sub-region was struck by catastrophic hurricanes which devastated several islands ina short space o f time43. However, a closer examination o fthe post-hurricane spending patterns in a number o f countries undertaken in the recent public expenditure reviews prepared by the World Bank (2004, 2005) also reveals that there is a tendency for subsequent increases in capital spending to becomepermanent 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 on 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 projectedeconomic and social impact. Many 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 duringbothproject preparation and implementation. 4.22 These issues have been exacerbated by a lack of coordination among donors, and inadequate oversight of project preparation by financing agencies. Ina 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 its PSIP, there were over 100 projects for a total capital expenditure of EC$66 million ranging from EC$12,000 to EC$35 million 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 is value for money. The World Bank's experience with financing civil 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: COMPARISONOFINFRASTRUCTURECOSTS 0 Dominica I the Grenadines ._________ Reinforcedconcrete Gabions Crushedstone base Source: Staff estimates. 4. 24 The following reasons have been suggested as contributing to the high costs o f public investment outputs. 0 Lack of standardized procurement rules which can limit competition between suppliers and service providers. 0 Over-design by 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 on an already agreed investment, "there i s definitely going to be a cost overrun, but we will deal with that problem when we get there, let's just get this project started." 0 Poor contract management as evidenced by the large number o f contracts in which the actual output or expenditure varied from what was contracted, but standard procedures were not followed to clarify or correct them. 0 Lack 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 from 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 decision- making on 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 this issue: ~ 44World Bank (20030. 42 0 A sub-regional program to reform and harmonize procurement systems would help to conserve limited technical capacity andhelp to strengthen controls and accountability. 0 Opening local biddingto the sub-regional market will help to prevent capture by local f m s . 0 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 on 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 incentivesregime 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 FDIwith respect to their GDP. However, in recent years this rankhas fallen and their share o f Caribbean FDIinflows 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 maintypes o f incentives: (i) statutory provisions which offer tax holidays or income tax relief, (ii) exemptions from taxes on imported products - some of which are specified in legislation and others which are at the discretion of 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 AidTourism Incentives Act, and an Aid to Pioneer/Development Industries Act aimed at the exporters, hotels and manufacturing respectively. Tax holidays are provided for each o fthese and inthe Income Tax Act as well. There i s involvement at a very highlevel of government for the approval o fbothstatutory 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 inthe OECS range from 5 years inAntigua and Barbuda to 20 years inDominica. InSt. Kitts and Nevis the duration depends on the size of the property, and in St. Lucia it i s share for extensions versus original construction, These incentives now violate the 1973 CARICOM agreement because they are awarded on 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 interms of foregone revenue. Unfortunately little data i s collected by any o f the governments on foregone revenue due to tax holidays, inpart 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 inAntigua and Barbudaduring2001-2003, and 5 percent and 6 percent o f GDP inDominica and St. Vincent and the Grenadines, respectively, in2001. 4. 34 In general, it is 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 on 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 inpractice. 4. 35 The negative impact of incentives-based competition for FDI is not only financial. Because they are not clearly based on 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. Inaddition, ifthey are applied ina discretionary manner as the majority are inthe OECS, they create uncertainty among investors as well as open the door for corruption and rent- seeking . 4. 36 The 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 Not 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, two 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 indrivingthe incumbent operator out o f business. 4. 38 Duty concessions and other exemptions from taxes on imports, which attempt to bring products closer to world market costs, are only required or demanded because of the high tariffs and other trade-related service charges imposed by 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 to 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 inthe 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 4.40 However, there has been a consistent stream of evidence46from 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 World Bank (2004b). 46 Lim(1983) andErnest& 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 ina recent review by Zee, Stotsky and Ley (2002). 4.41 This research has shown that firms generally make their investment location decisions in a two-stage process. The first i s based on `fundamentals" - the matchbetween country-specific conditions and the investment, the general investment climate, and the availability and cost of key factors of production, labor, infrastructure, etc. Inthe second stage, firms draw up a short list o f potential locations. At this stage, when alternative locations are otherwise closely matched, differences intax obligations can influence decisions at the margin. Annex 2 lists the alternative locations for OECS countries that were reportedina recent CaribbeanForeignInvestorPerception Survey. 4.42 When considering the FDI framework Caribbean investors did rank 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 inthe 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 PERCEPTIONSOF THE FDIFRAMEWORK F a v o r a b l e a t t i t u d e i n c o u n t r y t o w a r d s F D I 1- . ' "' I n v e s t m e n t i n c e n t i v e s I 1 I 1 1 1 I 1 l n v e s t m e n t f a c i l i t a t i o n a n d s e r v i c e s I 1 I 1 E x p o r t i n c e n t i v e s a n d E P Z s I l l I l l I l l I l l A c c e s s t o l o c a l f i n a n c e 1 1 1 1 G o v e r n m e n t a n d v e n t u r e c a p i t a l f i n a n c i n g 0 1 0 2 0 3 0 4 0 5 0 6 0 1 0 8 0 9 0 Source: World Bank (2004a). 4. 43 Competition among countries has made these incentives an even more risky and costly prospect for OECS 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 Hall Marina are two of the more costly experiences inthe sub-region. 4. 44 As para. 7.31 inthe tourism case study shows, simply competing by 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 or 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 on 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 is 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 on imports (see Table 4.2 below and Table 3.2 inChapter 3). Indeed, the surveyed investors ranked tax rates above investment incentives as a key issue intheir choice o f location (See Annex 2). TABLE4.2: TAXRATES Corporate Domestic Import Customs Service Income Tax Consumption Tax Consumption Tax Charge Antigua and Barbuda 35 15 15-50 10 Dominica 30 20 25 3 Grenada 30 5-10 15 5 St. Kitts and Nevis 35 15 25 5 St. Lucia 33 0-35 4-30 5 St. Vincent and the Grenadines 40 5-40 5-20 4 Source: Bain and dos Santos (2004). 4.46 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 on 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 own investments in education, training and national innovation systems. On the other hand, Mexico, whose approach to FDIwas primarily as a source ofjobs 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. Inthe OECS, this will require an appropriate export development strategy and a capable investment promotion agency. Box4.2: 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 afast-track permit process. For Costa Rica, Intel wouldprovide 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 ngfor 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, notjust 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'sjob descriptions, an troduce a one-year cert one-year degree program and language training. Source: Spar (1998). 46 4.47 One approachto reducing investment-based competition i s harmonization of regimes across the sub-region and the Caribbean region. However this i s likely to be very difficult. Recognizing this, LeCraw (2003) suggests two options for CARICOM which is in the process o f preparing a harmonized investment code: (i) a uniform low tax rate for all investments projects or (ii)low tax rate a combined with highly targeted incentives but with limits on the incentives that could be granted by member countries. As a start, it i s recommended that the OECS countries improve the level of transparency surrounding incentives by disclosing them to the public on a regular basis. Public scrutiny can go a long way to reducing waste. Inaddition "sunshine laws" can be instituted to require opportunities for public comment and access to records. D. Investmentpromotion 4.48 Notwithstanding the sub-region's success in attracting FDI, it i s safe to say that investment promotion as a public sector function in the OECS i s still in its 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. Inaddition, 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 be called investment promotion work, but this 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. More recently, governments across the sub-region have recognized the need to consolidate and dedicate resources to this 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,investmentgeneration, investmentfacilitation and investmentpolicy advocacy. Ofthe four functions, agencies inthe OECS tend to focus most o f their efforts on the last two 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" to reduce the burden on firms that need to receive approvals from a range of different entities before starting operations. In 2001, for example, its new Act established the St. Lucia Development Corporation as a one-stop shop for investors with the power to grant work permits and some licenses. However, in discussions with various line ministries and special offices each revealed their own role inthe investment approval process, not the least o f which was the Cabinet itself. This i s a common problem worldwide. To 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 -theyare not, however, then the procedures shouldbe eliminated. 4. 51 The implication is that establishing a one-stop shop is not simply transferring approval process but involves a whole review and possible re-engineering of these procedures. For these reasons, most one-stop shops have narrower mandates, with the authority to grant some approvals and provide assistance on others. Insome cases, the one-stop shop may house staff from relevant agencies, Box 4.3 showcases some remedies that have beentried inother 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 turn around applications within afew days. The rapid und is due in part to a "no objection" provision 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 notjust constitute an additional regulatory burden. Ifi Thailand, the Investment Services Center can issue establishment licensesfor 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 theprocess, manyfirms 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 shiftingfrom a pre-auditing to apost-verification system, the One-Stop Service Center for Visas and Work Permits in Thailand reduced the time it tookforeign firms to get visasfor foreign workersfrom about 45 days tojust 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 is clearly identified and the high costs of these two functions. The first underscores the reactive nature of governments in the OECS to FDI. However, as recommended throughout this report, it is 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 of being buffeted by the waves of 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 of information most commonly used by investors inthe Caribbean and in Grenada about a particular country. It was found that inmost cases, firms 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: SOURCESOFINFORMATIONFORFOREIGN INVESTORS CARIBBEAN-WIDE GRENADA h t m l F'ublishedIC reports indicators 1 - Discussions W d l 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 be much better targeted to the types o f firms 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 incountries 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 inper capita terms, especially at the image buildingstate. 4. 55 This analysis suggests the need for the OECS to re-consider a joint approach to investment promotion4' to reduce costs. This assumes that the sub-region agrees on a joint strategic vision for the OECS, and that competition among the countries for investments be reduced. TABLE4.3: THECOST OFINVESTMENT PROMOTION Annual FDI promotionbudget Population Per capita (US$million) (millions 1999) budget (US$) Singapore (EDB) 45.0 3.2 14.06 Ireland(IDA 1999) 41.0 3.7 11.16 CostaRica (CINDE) 11.0 3.5 3.14 Mauritius (MEDIA 1986) 3.1 1.2 2.58 DominicanRepublic (IPC) 8.8 8.4 1.05 Malaysia(MIDA) 15.0 22.7 0.66 Note: The text inthe parentheses is the acronym o f the respective country's investment promotion agency. Source: World Bank (2004b). E. The regulatory framework and administrative efficiency 4. 56 In addition to being small economies, where markets face a greater risk of monopolies or oligopolies, the OECS countries have further discouraged domestic competition through the use of price and investment controls, and government ownership of commercial enterprises. More than half o f the firms 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 still 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. For example, the Nutmeg Board in Grenada retains a monopoly on purchasing which is currently hindering a new entrant seeking to produce value added products from purchasing supplies at farm gate prices. In Dominica, the long-standing dominant position o f the Dominica Banana Marketing Corporation (inpart 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 inthe supply chain for farmers. Inother countries the government still retains significant or complete ownership in a number o f commercial state enterprises, ranging from commercial banks, dairy farms, housing development projects, radio stations, hotels, flour mills, which entitle these firms to special treatment. 4. 57 In general, the Government's rationale for entering the market is to prevent the abuse of monopoly power by dominant private operators or to achieve some social goal not being delivered by free market competition (for example through the bulk purchasing, packaging and distribution on basic food items). Inthe latter, the resulting benefits are rarely effectively targeted to the poor and needy. 48Inthis regard it will be important to revisit the experience o f the joint Eastern Caribbean Investment Promotion Eastern Caribbean Investment Promotion Service (ECIPS). For several years, the OECS maintained ECIPS with donor support. The Service was geared to 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 Inthe 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 fthe firms 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. 58 Finally, most OECS countries have an established negative list 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 to be the director o f a domestic company. Inaddition, transfers between local foreign residents usually attract a higher tax than transfers between local residents. While the issuance o f licenses and concessions on the transfer tax are reportedly fairly common, these still incur costs and time delays for investors. The general intention o f the land licenses i s to deal with the problems o f land price speculation and reduction in the access o f land to low or middle-income residents. However, it i s not clear that alien landholdingregulations are the most effective mechanism to achieve this goal. 4. 59 Outdated investment codes in some countries create a level o f policy uncertainty for the private sector as to whether certain elements will be enforced or not depending on government discretion. One of the possible areas for policy reform is 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 its more unified investment regime. 4. 60 Although administrative efficiency in not generally thought of as an area of strength for the OECS public sectors, firms interviewed and surveyed for this study did not raise it as a critical issue, Indeed ina 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). InGrenada, the majority o f the private firms have a fairly positive view o f government efficiency, and the consistency and predictability of 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 still considered quite manageable. 50 FIGURE 4.4: FOREIGN INVESTORS' PERCEPTIONS OF THE INVESTMENT CLIMATE Infrastructure I I 1 1 Labor 4 Policy& LegalEnGronment I Quality of Life 4 I Taxation andCustoms FDIFramework Market Access AdministrativeProcedures 3 3.5 4 4.5 Grenada performance Caribbean-wide performance 0Caribbean-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: World Bank (2004a). 4. 61 There were two notable exceptions - tax and customs administration. Throughout the OECS tax administration is 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. Inmost countries, the tax administration's powers, taxpayers' rights, penalties and interest provisions are dispersed inseveral tax acts, and it is 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 on the incidence o f tax payments, the survey inGrenada 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 inthe previous section) could contribute significantly to reduce these problems. Inaddition, boththe recent IMF study on taxation administrationinthe OECS andthe work of the sub- regional Tax Reform and Administration Commission (2004) have recommended the establishment of a regional tax authority as a way o f more effectively utilizing the limited capacity across the member countries. 51 TABLE4.4: FIRMRESPONSESTO ADMINISTRATIVE PROCEDURESINGRENADA o/o of respondents who rate N o A Minor1Moderate A Major1Severe the issues as: Problem Obstacle Obstacle Entry procedures Business registration 83.1 13.4 1.5 Business licensing 77.1 17.4 3.0 Proc. for access to land & premises 67.7 20.9 9.0 h o c . for utility hook-up 63.2 29.4 5.5 Operatingprocedures Business inspections 77.6 17.4 2.5 Fire, safety and sanitary regulation 74.6 17.9 5.5 Labor regulation 61.7 26.4 10.0 Tax administration 59.7 31.3 7.0 Customs regulation 39.8 40.8 16.9 Other procedures Patent and trademark reg. 81.1 14.4 1.5 Competition regulation 76.6 13.4 7.5 Foreign exchange regulation 74.1 19.9 4.0 Price regulation 68.7 20.4 9.0 Standards and certification 66.7 22.9 8.5 Source: World Bank (2004e). 4. 62 Among all government regulations that affect business operations, by far the most serious constraint i s customs regulations. InGrenada, firms 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 is generally associated with expediting process rather than tax avoidance. 4. 63 Many of the OECS countries are trying to reform their customs services, but few have had significant success in part because of the incentive structure facing customs departments. Given the countries' reliance on trade taxes, the fiscal imperative to raise revenues, and the widespread use o f concessions, customs departments are generally not oriented toward trade facilitation. However, because of the reliance on imports throughout the whole productive structure o f the economies, these time- consuming 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 raw materials through customs, which reducedhis manufacturingtime by more than half andjeopardized a significant export order, 4. 64 With both customs and tax administration, e-government can provide an important mechanism to improve service, increase transparency and promote technological development. Systems such as the Automated System for Customs Data (ASYCUDA) 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 world in which countries have revolutionized both 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 to private businesses to upgrade their own systems in order to take advantage o f the new way 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: STAGESOFE-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,Jassodra2003, Source:InfoDev (2005). 4. 65 Inimplementingsuch systems, however, two considerations are worthnoting for the OECS. The f i r s t i s that the cost of these systems, as recently shown by the Caribbean Regional Technical Assistance Center (CARTAC) for ASYCUDA, may be prohibitively expensive for small administrations such as are found inthe OECS. As such, a sub-regional effort for automating customs and tax administrations may be the best way forward. In this regard, CARTAC is undertaking a feasibility study o f such a system. 4.66 The second consideration is that simply introducing the system without changing the underlying rules will limit its potential to improve the business climate. Public sector administration in the OECS is fraught with multiple layers of approval that delay and obfuscate what are normally simple, rules-based administrative processes. For example, inAntigua and Barbuda the Minister o f Labor must sign every work permit application leading to long time delays for investors. As illustrated above by the discussion on both procurement and investment promotion, these layers of approval often do not add to the quality o f the decision-making, and often provide opportunities for patronage. Introducing e- government provides an opportunity for administrative reform in the processes and procedures that would further enhance the business climate. 53 CHAPTER 5. SKILLS, WAGES,AND THE LABORMARKET 5. 1 The skill endowments o f the labor force are indispensable for technology absorption, productivity improvement, diversification and overall competitiveness. Building a strong skill base is particularly important for competitiveness in the OECS countries because o f their reliance on 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 firms 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 inthe 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. It prioritizes policy recommendations around three themes of: (i) improving quality o f education, (ii)increasing access to tertiary education and job training through improved allocation o f public spending and greater private involvement, and (iii) producing skills 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 on 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 CSME protocol on free movement o f labor. A. Skills, education and training 5.4 Skills are important for achieving and maintaining competitiveness. The skills 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 skills 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 skills 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 firms to adopt and develop new technologies that are more skill 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 skill base i s also particularly important for economies in transition. Box 5.1 illustrates how a skilled labor force can help a region in the search for new sources o f competitive advantage duringa period o f structural adjustment. 54 BOX 5.1: HOWTHE SKILLSBASEHELPED BOSTON STAY ONTOP TO may be even more important whenfacing adverse economic conditions. A high stock of human capital aliows both workers andfirms in a region to acquire new competencies and adopt new technologies faster, and thereby gain new areas of competitiveness. Glaeser (2003) examinesBoston as a case study of regaining competitiveness. Boston successfully bounced back from three economic crises that each could have leJ2 the region stagnated and abandoned. First, the city transitioned from a dying seaport t iving base of global shipping and fishing 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 economy based on highly adva competences in biotechnology Boston's excellent pe$ormance 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 skill base is 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, movingup the value chain inservices will entail increasing numbers and levels o f skills inthe labor force, Ina survey offoreign investors acrosstheCaribbean, firms inthe service sector standout as requiringfar more professional and skilled labor, than their manufacturing counterparts (see Figure 5.1). Inaddition, 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 highlevel o f scientific training intheir work. FIGURE SKILLSCOMPOSITIONOFA SAMPLEOFFOREIGN 5.1: FIRMSINTHE CARIBBEAN(%) Agriculture Food p x e s i n g Textile & garments Electric & electronics Other Manufaclunng Tounsm Wrofessionals Financialservices "Skilled Workers ICT-enabledsemces OUnskilledWorkers M e d r alsemces Professional Semces T"port Conslruction Energy Retailkholesa b Semces I 0 20 40 60 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-speakingworkforce, the public and private sector alike report severe shortages o f skilled labor across the sub-region. Ina survey o f 24 export firms 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 firms in Grenada, where a diagnostic o f the investment climate was conducted in 200450(see Annex 1). 5. 7 The shortages are found invery specific skills like equipment mechanics for food processing companies, as well as in more broadly applied skills such as accounting and information technology. As identifiedby the enterprises surveyed for the recent Diagnostic o f the Investment Climate in Grenada," the key skills shortages are found in technical skills such as industrial engineering, and managerial skills at middle and senior management levels. FIGURE MAJOR 5.2: OBSTACLESTO FIRMCOMPETITIVENESSIN GRENADA (%of respondents) Skills & e d u . o f available w o r k e r s C o s t o f f i n a n c i n g T a x rates A c c e s s to f i n an c in g E le c tric ity C r i m e , t h e f t & d i s o r d e r E c o n o m i c & r e g . p o l i c y u n c e r t a i n t y T r a n s p o r t a tio n : in t e r n atio n a I A n t i . c o m p e t i t i v e p r a c t i c e s M a c r o e c o n o m i c instability C o r r u p t i o 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 T r a n s p o r t a t i o n : C a r i c o m L a b o r r e l a t i o n s T e l e c o m m u n i c a t i o n s A c c e s s t o l a n d T r a n s p o r t a tio n : lo c a l H e a l t h o f w orkers ( A I D S I H I V ) 0 IO 2 0 3 0 4 0 S O 8 M a j o r o b s t a c l e O S e v e r e o b s t a c l e Source: World Bank (2004e.) 5. 8 The dearth of skills is 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. Of 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 skills inmarine 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 FILLA VACANCY INGRENADA TO Management Skilled worker Unskilled worker No vacancies reported ("A firms) 29.4 23.9 12.4 Median delay (weeks) 8 4 1 Source: World Bank (2004e). 49Madsen (2004). 50A full descriptionofthe survey is providedinAnnex 1. 51World Bank (2004e). 56 5. 9 The shortage of skills i s also reflected in increasing returns to education. Table 5.2 reports the average difference in wages in various Caribbean countries, between workers with specific skills levels and workers with only primary education.52 The variation o f returns across countries reflects primarily differences inthe quality o f education and thus worker productivity, the supply o f skills to the market, and wage-setting practices. Higher returns generally signal more scarcity. Inthe 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: INCREASINGRETURNS EDUCATION TO Percentage (YO)higher wage received Secondary Post-secondary University than aprimary education holder: Barbados 17 35 72 Dominican Republic 72 146 210 Guyana 42 74 110 St. Lucia 34 165 223 Trinidad and Tobago 25 89 186 Source: Various national labor market surveys and World Bankstaff estimates. 5. 10 The shortage of skilled labor in the OECS results from a number of compounding factors. The first i s relatively low educational attainment, in terms o f both numbers and quality o f secondary education graduates despite recent progress in expanding access, and low 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, inpart, related to the higher costs o f in-firmtraining 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 skills differential and already high costs o f training, and as such limit the supply of trainable jobs. Steady flows of migration have served to fixther exacerbate the shortage o f skills. (i) Basicandsecondaryeducation 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 on primary education first. A comparison o f educational attainment in St. Lucia between 1980 and 2000 indicate rates o f increase that may be on 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 Math 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 no OECS country, indeed no Caribbean country except the Dominican Republic, participates in internationally recognized assessments o f schooling 52 This exercise was only completed for St. Lucia in the OECS because it 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 two data periods. 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 Secondary Estimated Gross Gross CXC pass rates Range of CXC tertiary enrollmen completion English Math passa enrollment Antigua and Barbuda 81 58 34 Dominica 91 56 66 45 56% - 96% 8 Grenada 88 84 46 35 18% - 90% 13 St. Kitts and Nevis 100 67 53 46 64% - 80% 12 St. Lucia 77 72 58 39 36% - 96% 14 St. Vincent and the Grenadines 67 51 61 37 41% - 81% 5 OECS (pop-wtd) 81 67 56 38 11 Caribbean b,c 75 46 36 21 Micro states 80 Upmiddle inch 83 LatinAmerica 69 NA 24 World 70 26 a. in General Proficiency. b.Not including the OECS countries. c. Belize, Barbados, Dominican Republic, Jamaica. Sources: di Gropello (2003). CaribbeanExaminations 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 on education but how it is spent that i s important". Inefficiently low 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 on salaries (92 percent) leaves far too little for other critical inputs into learning outcomes, such as materials and school maintenance. 5. 13 In 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. It i s important to note that while curriculum reform has been on 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 on 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 on 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,s5but this effect disappears inthe Caribbean sub-sample including the OECS countries. Inthe Caribbean as well as in states with populations under 10 million, primary school pupil-teacher ratios rise with population, but without associated increases in per capita spending or reductions inprimary education outcomes (as measured in secondary enrollment rates). This 54 It i simportant to note that in the OECD countries, private spending o n education adds another 1.3 percent o f GDP 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 inthe OECS to reallocate spending from teacher salaries to other areas, without radically increasing per capita spending or reducing outcomes. TABLE5.4: EDUCATIONINDICATORS Pub. exp. on Pupilteacher ratio YOtrained % of current educ. as YOof primary secondary teachers salaries admin. Antigua and Barbuda 4.2 17 15 67 Dominica 7.1 18 18 23 92 10 Grenada 6.8 23 23 31 82 10 St. Kitts and Nevis 7.5 18 13 29 95 10 St. Lucia 7.1 26 18 57 92 9 St. Vincent and the Grenadines 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 on access, this masks serious inequities in the quality o f education received by students. The range o f CXC pass rates across schools inthe OECS varies from as low as 18 percent to as highas 90 percent across very small numbers o f schools in each country (between 2 and 18 schools). This is surprising insuch small and egalitarian societies which have traditionally placed such a highvalue on both education and on the equitable distribution o f benefits from development. The strikingdisparities are illustrated inBox 5.2 below ina comparison o f two highschools inone 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. Theformer is located in the capital and the latterjust outside. At the CXC examinations in 2003, 2percent of the exam-takers passed Math and 52 percent passed the general proficiency requirement at CHS, whereas at GHS, 89percent 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) schoolfinancing; (ii) academic selection; (iii) familial and institutional enabling environments; (iv) quality of teaching stafl and (v) infiastructure. 0 Schoolfinancing. 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 faver extra-curricular h employs both a counselor and nurse, and the GHS 0 School infrastructure. GHS sports afairly well-equipped library and science labs in sharp contrast to CHS' run-down infiastructure. 5. 16 There is a commontendency 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 CXC examinations, with little attention to the average performance o f the country as a whole. Not only i s the public financing policy regressive, it appears to pin the hopes o f an entire nation on a few elite performers, when global competitiveness depends on the average level and quality o f education o f the workforce. There is a general shortage o f detailed public information on the distribution o f inputs and individual school outcomes. For example, neither the Caribbean Examinations Council nor individual governments make publicly available annual results by school. This may have reduced accountability regarding the administration o f education systems to the public by masking the low average quality o f education, thus dampening the demand for improvements. 59 5. 17 One 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 inthe 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 World Bank study on 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 inAntigua and 2.6 percent in St. Lucia. Highyouth unemployment i s also an indication that low secondary education outcomes are contributing to low tertiary enrollment and inadequate job training, by reducing the pool of suitable candidates for these forms o f continuing education. TABLE5.5: YOUTHUNEMPLOYMENT Year of Unemploymentrate Youth share of source data Youth Adult unemployment Antigua and Barbuda 1991 13.0 4.2 47.0 Dominica 2001 56.0 16.7 50.1 Grenada 1998 23.9 9.2 49.0 St. Kitts and Nevis 2001 11.0 3.6 44.0 St. Lucia 2001 36.8 11.7 48.6 St. Vincent and the Grenadines 2001 39.4 15.3 45.3 OECS 31.9 10.8 47.6 Sources: Halcrow (2002), country labor force surveys, censusesand Bank staff estimates. (ii) Tertiaryeducation 5. 18 The OECS also has a serious shortfall in tertiary education output. The OECS remains far behind its competitors intertiary education with enrollment rates estimated at around 11percent 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 its 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. In2001, 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 low demand due to inadequately qualified candidates i s still 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 on 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 low cost-recovery from students (with the exception o f Dominica where 13 percent o f costs i s collected in tuition fees), this has meant severe 56 In Dominica where we have recent data, unemployment among poor youth is even more acute - among both poor and indigent5615-24 year-olds, the unemployment rate is estimated at an astonishing 74 percent. '*World 57 World Bank (2003b). Bank ( 2003e, 2004f, 2004g, 2004h, forthcoming). 59 Theprivate sector is the mainprovider of offshore education (serving foreign students) inthe OECS. 60 limitations on the number o f places and quality o f instruction. The private sector i s now beginning to emerge as a significant provider in Grenada with 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 on 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 1percent. FIGURE TERTIARYEDUCATION: 5.3: INVESTMENT AND ENROLLMENT (2000) 2 3 . 0 n 45 8 2.5 40 rc 35 p sO 2.0 30 c, zc1 . 5 25 2 1.0 t 20 g 15 2 8> 0.5 U 10 15 5 5 0.0 0 Source: UNESCO (2002), various country sources and staff estimates. 5.21 Public institutions are inefficient and spending is likely to be regressive. In addition to the limited fiscal resources available for tertiary education, there are some key inefficiencies in how 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 infull-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 well known to be highly regressive spending, since limited places go to the best performing students who generally come from middle-to-high income households. On the other hand, purely private financing i s associated with large inequities. For 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 burdeno f tuition fees and foregone income. 5.23 Public spending on tertiary education may not be sufficiently geared to the needs of the private sector. In addition to reforming the financing structure o f public tertiary institutions, the OECS needs to ensure that the curriculum and offerings are appropriate to 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 be 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 its own sustainability) and national colleges which strive to produce knowledge workers for the local economy. 6oFurther details can be found inthe OECS Analysis o f Fiscal Issues series. 61 5. 24 To address the shortages, the OECS will need to ensure that the few public tertiary institutions contribute efficiently and effectively to solving the skills 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 inthe sub-region (see Box 5.3). BOX 5.3: ACCOMMODATINGTHE TRAININGNEEDSOF THE PRIVATE SECTOR TheBarbados 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 hasput into action several strategies to ensure that its offerings and graduates meet theprivate sector's needs, including: (i) An external governing board that counts sevenprivate 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 andprovide hands-on experiencefor students, but also augment the College's revenue; and (iv) Facilitation of staff exchangedattachments withfirms throughflexible 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 to 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 inareas 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 on the tertiary education services. Inaddition, the Governments could encourage more innovative use o f ICTs to provide local students with access to distance learning opportunities as proposedunder the Caribbean Knowledge and LearningNetwork. 5. 26 At the minimum, the OECS 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 be best served by taking advantage o f already internationally-recognized certifications and relying as much as possible on Caribbean regional efforts, such as the RegionalNursingProgram. 5. 27 Close attention should be paid to trade negotiations on the treatment of tertiary education. Inthis regard, the OECS needs to consider carefully its stance regarding the treatment of tertiary education under the General Agreement on Trade in Services. The US, the world leader in export of education services, has sought full market access and national treatment from its trading partners for its modes 1,2, and 3 higher education and training services providers.61 Ineffect, they are seeking free entry o f US 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 on market access and on national treatment only in modes 1, 2 and 3, but requiring local certification, registration and licensing of institutions in mode 3. Jamaica has no commitment inmode 4 which requires work permits and visas except from CARICOM citizens. 62 received by local institutions. Regarding the latter, there is an outstanding issue as to whether `national treatment' includes subsidies and concessions provided to public training and tertiary institutions, such as UWIand the Clarence Fitzroy BryanCollege in St. Kitts and Nevis. Inthe Caribbean, some educators have cited this issue as reason to propose preventing entry by foreign training institutions, but this would only perpetuate the shortage o f tertiary education offerings within the sub-region. Instead, the OECS trade stance inthis 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 segmentedlabor market space in the OECS. The labor market inthe OECS remains a geographically fragmented space, as most governments still restrict the free movement o f workers across countries. Under current agreements, the sub-region is committed to free movement o f labor only by 2007. Although some rules have been relaxed ina few countries, work permits are still required for most OECS nationals to work in another member country. This has a dampening effect on the demand for certain types o f specialized tertiary education. The smaller the market space, the more limited the scope o f opportunities as perceivedby school graduates, who will only seek training for those positions inwhich 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) Jobtraining 5. 29 Job training is an important part of the supply chain for skilled labor. The aim of job 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 firms generally choose to train employees only ifthose employees are adequately educated, and opportunities for the introductiono f new technologies exist. Training therefore often has an incremental character. The decisions regarding training- the skills to be acquired, the duration o f the training programs, and the choice o f service providers-should be made by the firm itself, inorder 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. It i s therefore critical that job training be highly demand driven in order to be effective in improving employee productivity as well as ensuring job-placement for unemployed. 5. 30 Job training appears to be lower in the OECS than in the rest of the Caribbeanand Latin America. Approximately 65 percent o f firms in the Caribbean provide training to their workers (85 percent o f firms in the Dominican Republic, 65 percent in Belize, 54 percent in Haiti, 41 percent in Trinidad and Tobago, and 90 percent inJamaica), which i s lower than the regional average o f 75 percent of firms for Latin America. Less than 50 percent o f f m s surveyed inGrenada62provide formal training to their workers (see Figure 5.4). Although foreign companies are more likely to offer training than domestic companies and larger establishments tend to train more than smaller ones, there remain a considerable number o f firms - a third or more -that do not provide any training to their workers. 62World Bank (2004e). Also see details inAnnex 1. 63 FIGURE5.4: SHAREOFFIRMSOFFERING FORMALTRAINING INGRENADA (% of respondents) Large M e d i u m Small M i c r o Foreign Domestic Tourism Manufacturing Total 0 10 20 30 40 50 60 70 Source: World Bank (2004e). 5, 31 Job-training i s a complement, not a substitute for basic education. Evidence from across the Caribbean confirms this. InJamaica and the Dominican Republic, more than three quarters o f recipients of training hold 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 inGrenada, 84 percent said they provided formal training to skilled workers in2003, but only 31 percent indicated that they offered such opportunities for unskilled workers. Unskilled workers are generally not considered "investment-grade" inthat 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 is 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 firms. 5. 32 Public training programs are not well geared toward the needs of the private sector. Table 5.6 illustrates the distribution o f investments intraining by firms surveyed inGrenada. 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 skills 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 its training program and highemployee turnover for having trained most o f the local massage therapists, thus facilitating the introduction o f health and wellness services at other properties on the island. Most of the companies surveyed in Grenada recognize the merit o f formal training in skills upgrading, but are not satisfied with the available training facilities. According to these enterprises, the Government should collaborate with the private sector to provide more training programs inall areas, and schools shouldbe encouragedto expose youngpeoplemore to the world ofwork inorder to prepare them better for thejob market. 64 TABLE 5.6: TYPES TRAININGINSTITUTIONSUSED BY FIRMSIN GRENADA OF SkilledWorkers UnskilledWorkers YOof respondentswho used External External these types of institutions Internal Private Public Internal Private Public Total 77.6 52.0 19.4 92.6 31.5 13.0 Manufacturingfirms 61.9 36.6 1.5 96.4 3.6 0.0 Tourism firms 56.3. 25.8 18.0 79.8 16.8 3.3 Domesticfirms 52.7 35.7 11.7 79.1 16.5 4.4 Foreign firms 67.0 30.5 2.6 91.4 8.6 0.0 Micro firms 61.3 27.7 11.0 98.0 2.0 0.0 Small firms 56.9 28.1 15.1 91.7 1.1 7.2 Medium-sizedfirms 49.6 48.0 2.4 68.9 28.5 2.5 Large firms 56.9 35.5 7.5 78.3 18.3 3.3 Source: World Bank (2004e). 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 skills for traditional microenterprise development such as dressmaking and carpentry rather than building skills for the formal labor market. Though usehl, they have little impact on the competitiveness o fprivate firms, and do not promote innovation inthe 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 on training goes toward youth and vocational training, with the remainder on 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 job training towards demand-driven and incentive-based training schemes where firms 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 firms, aims at directly developing the capacities of the work force andthereby contributes to private sector productivity improvements. This appears to be a Caribbean best practice inthis area. Enterprise Training Youth and vocational training 0 Apprenticeship 0% Dominican Jamaica St. Lucia Trinidad 8 Republic Tobago Source: McArdle (2004) . 5. 34 Outcomes of donor-financed training programs have not been well measured. Inthe 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 firms' productivity, sales or exports. Inone 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 inworker productivity. 5. 35 Despitethe apparent willingness of private firms to train their workers, the under-provision of job training inthe OECS will persist if left entirely to the private sector. This i s because firms are reluctant to train employees in general portable skills 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 inpromoting training. 5. 36 The international best practice i s to separate public financing from 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. InOECD and Latin American countries, governments have opted to separate public financing from provision o f job training, because o f disappointing results with public training programs. Instead they now provide incentive schemes for firms 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 to provide financial incentives to firms for training (Malaysia, Chile, Brazil, Mexico, to name a few) from which the OECS can draw. 5. 37 Small market size may hinder entry of private training providers to the OECS. To 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. Not only will this create a large market space and encourage more private suppliers, but it will 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 interms o f buildingand improving the skills base o f its 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 on buildingskills demandedby employers. 5. 39 Improving the quality of education. Key action here will be to improve the efficiency o f public spending on education by: 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) will help to conserve limited resources, achieve economies o f scale and facilitate teacher mobility/deployment across the sub-region. 0 Shifting resources from better uerforming schools to 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. 0 Accelerating the reform o f secondary education curriculum to provide youth with appropriate competencies and skills for the further education andor the transition from school to work. In this regard, the performanceand accountability o f the OERUneeds to be strengthened. 0 Improving monitoring and international benchmarking of, and uublic information on. education outcomes across the sub-region. This is intended to increase accountability o f education 66 providers for educational outcomes, and deepen involvement o f the public inachieving education goals. 5.40 Expanding access to secondary and tertiary education. In addition to improving quality o f education, it i s imperative that the OECS continues the rapid expansion o f access to secondary education undertaken inrecent years, and begins to expand tertiary education, by: 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 will 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 on free movement o f labor within the OECS and under the CSME. 0 Improving. the efficiency o f spending. on tertiarv education by increasing cost-sharing, and appropriately targeted loan or scholarship programs. Inthis regard, the sub-region should take a close look at reforming teacher and nurse training programs. 0 Negotiating. better terms o f trade for tertiarv education services to increase spillovers to domestic needs. In promoting further the development of exports o f education services, the sub-region should target those areas that also have an impact on domestic needs, such as tourism, IT, and other areas. 0 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 sub- region 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 on the skills needed by employers and the labor market. Inthis regard, the OECS needs to: 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 job training programs to ensure that curriculum and course offering are relevant to market needs. 0 Expand skills training in some key areas such as IT, hospitality, non-hotel tourism services, accounting and management. 0 Refocus public spending on training by targeting vocational training on linkages with export sectors rather than on microenterprise skills that only provide safety nets for beneficiaries, and promoting in-firmtraining through thejudicious use o f financial incentives. B. Wages and the labor market 5, 42 Comparatively high wages accompanied by persistently high unemployment suggest that labor markets in the OECS may not be functioning efficiently. Table 5.7 presents data on 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. 63 One o f the challenges associated with labor market analysis in the OECS is 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 is 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. 67 Check- Bank Bank out Clerk/ Clerk/ Qualified Branch Branch Constru Clerk in Kitche Teller, Teller, Teacher Mgr, Mgr, Gen. ction Large n local foreign Garage Payroll inState local foreign Reg'd Worker Supmkt Porter bank bank Mech. Clerk School bank bank Nurse Hourlywage inUS$ Annual wag inUS$'OOOs Caribbean* 2.09 1.70 1.78 6.4 6.5 6.6 6.0 7.5 22.4 29.5 9.3 Upmidinc* 2.03 1.76 1.65 6.2 6.2 6.1 6.7 6.9 21.3 26.4 7.2 Micro state* 2.01 1.90 1.83 5.7 6.2 6.8 6.6 7.2 26.3 34.3 8.0 OECS 3.45 1.84 1.51 7.8 8.6 7.4 7.5 9.8 32.0 37.1 10.1 Antigua and Barbuda 4.07 3.33 2.45 10.9 10.9 9.0 12.0 8.8 55.6 55.6 12.9 Dominica 2.30 1.84 1.30 8.2 9.3 5.1 6.0 10.3 19.9 22.1 9.9 Grenada 3.03 1.80 1.26 7.1 8.0 9.5 8.1 8.6 26.5 30.9 7.5 St. Kitts and Nevis 5.30 1.40 1.90 6.7 7.0 8.9' 9.1 12.6 23.0 40.4 12.5 St. Vincent and the *Grenadines 2.53 0.81 0.63 6.3 8.2 4.5 2.7 8.5 35.2 36.3 8.0 Each comparator group excludes the OE( 1 countries. Source: CommonwealthlUNCTAD (2002). 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 on the trends inprivate sector wages, the lack o f persistent vacancies, highturnover or long queues for government employment inmost countries (again with the exception of 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 havebeengrowing at similar rates as public sector wages, and also exceedingproductivity growth. 5.44 High labor costs unless justified by high productivity only serve to hurt competitiveness and limitjob growth and generate unemployment. Indeed, unemploymenthas been persistently highinthe 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). Both problems impact competitiveness negatively - high wages because it raises the cost of production and unemployment because it wastes a crucial factor o f production. TABLE5.8: UNEMPLOYMENT TRENDS 1991 Mid 90s 2001 Antigua and Barbuda 6.0 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 inparentheses 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, rural 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. InDominica, 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 inDominica and St. Lucia. 5. 46 Inaddition, the duration of unemployment appears to be quite longwith the majority of the unemployed experiencing spells of one year or longer. The shift toward services has implied a radical shift in the skills needed by new employers. Workers who are being increasingly retrenched from old sectors need time to acquire the necessary human capital appropriate to the new economy jobs. Delays in adjusting the curricula o f job training programs only prolongs the skills mismatch in the economy and exacerbates the unemployment situation. Clearly, the major challenge for the OECS inthe coming years will be to equip this large share o f the labor force that are currently chronically un- or under-employed withthe skills required by growing and emerging sectors 5. 47 As a result, the OECS also appears to be experiencing an increase in informal employment as workers from 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 low value-added service activities such as street vending and petty trading. Inthis respect, it i s a source o f employment for low 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 on informal sector jobs has economic costs - particularly in the long run - because workers tend to be unskilled and perform tasks with low value-added. So although informality in some ways helps labor market competitiveness through lower wages and increased flexibility, a forward- looking strategy o f increased growth and competitiveness through higher labor productivity will require addressingthe incentives for informality. 5.48 In 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. Inreality, however, there are a number of labor market imperfections - both structural and frictional - that restrict job growth and keep unemployment high in the presence o f highwages. The labor market can be segmented in a number o f ways that prevent surplus labor for being channeled toward labor shortages. It 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 preventingthe 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 skills or there i s a mismatch between their skills and those required by the demanding sector. There may be a long lag between changes in demand for certain skills 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. Inaddition, workers have few means of 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 firms are often reluctant to provide training for unskilled workers because the kindo f skills required are very portable and the firms risk training workers who then leave. Inother cases, the worker's skills deficit i s so large that investments inretooling 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 on the labor market by drivingup 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 unionizedworkers can also leadto 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 inthe labor market. For example, across the board improvements in the government wages (or allowances) may 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 inthe 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 Rigid labor regulations. Labor regulations can make it difficult or costly for firms to adjust the size or the composition o ftheir workforce or simply replace less productive with more productive workers, as they try to implement improvements needed to become or stay competitive. 0 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 integrationof 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 skills has been discussed indetail inthe previous section. 5 . 50 In most of 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, ECTEL - accounts for approximately 20 percent o f employment and the wage bill for 13 percent of GDP. Inpart 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 WAGES AND CentralGovernment (2002) Average Annual Growth (1995-2002) YO Real Wage bill Empl Emp YO YO No. Nom. CPI Real pc YoGDP (000s) a LFa Pop positions wages (Inflation) wages GDP Antigua and Barbuda 12 13.0b 34 31 17 0.7 Dominica 15 5.5' 20 17 5 2.1 2.8 1.3 1.5 0.7 Grenada 11 5.1 5 12 5 -0.5 5.0 1.9 3.1 2.7 St.Kitts and Nevis 15 4.7 29 28 10 4.4 2.3 3.4 -1.1 2.3 St.Lucia 11 6.8 11 9 4 0.7 4.7 2.1 2.6 -0.4 St.Vincent and the Grenadines 14 6.1 27 27 6 2.2 4.4 1.3 3.1 3.9 OECS 13 41.2 21 19 7 1.7 3.8 1.7 2.1 1.5 a. LF=labor force. Extrapolated from most recent labor force or census data. b.Broadestimate of central government employment, becausemore precise numbersare not available. c. Includes an estimated 1600 non-established workers who may not be full-timeequivalent employees. Sources: World Bank (2003e, 2004f, 2004g, 2004h, forthcoming) and IMFestimates. 70 5. 51 As noted above inpara. 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 inthe OECS emerged inconjunction 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 links to political parties on both sides o f the aisle. This has served to make wage and other negotiations with the public sector unions across the sub- region are generally quite fractious, and has severely limited governments' abilities to achieve wage moderationand 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 (12 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 inthe 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 inDominica 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 on 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 part 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 inBarbados under its 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. InSt. Vincent and the Grenadines, the trade unions participate inthe National Economic Council. InDominica, albeit not entirely smooth-sailing at first, trade unions participatedfully in consultations on 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 inbroadeningpublic ownership o f necessary reforms to contain the size o f government and its impact on 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 to be relatively cordial. Most o f the companies surveyed in Grenada, as well as the majority interviewedinother countries, reported generally cordial relationships between labor and management, which inturn was confirmed by the trade unions. Only three companies out o f the 201 surveyed in Grenada reported days lost due to 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 inGrenada. 5. 56 In comparison with other countries, labor market regulations in the OECS 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 World Bank's Doing 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, inthe second best quintile, in terms o f overall rigidity o f employment, it performs poorly on 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. It 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 job security regulation, the strong rule o f law in the OECS translates to frequent and costly judicial actions on both collective and individual labor disputes. TABLE5.10: INDICESOFLABOR MARKET FLEXIBILITY Rigidityof Q Difficulty Q Difficulty Q Rigidity Q Firing Q Employment o f Hiring of Firing o f Hours costs OECS 22 2 23 3 40 4 4 1 59 4 Other micro states 7 1 8 1 5 1 8 1 15 1 Upper middleinc 28 2 27 3 22 2 35 2 38 3 Dominica 37 3 50 4 60 4 0 1 57 4 Grenada 20 1 0 1 60 4 0 1 28 2 St. Kitts andNevis 7 1 0 1 20 2 0 1 62 4 St. Luciaa 39 3 67 4 30 3 20 1 108 5 St. Vincent and the Grenadines 10 1 0 1 30 3 0 1 42 3 DominicanRepublic 40 3 11 2 30 3 80 5 70 4 Haiti 24 2 11 2 20 2 40 2 26 2 Jamaica 10 1 11 2 0 1 20 1 12 1 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 OECS countries impose tenure-based severance payments and provide for relatively complex appeals processes in an attempt to safeguard job security and employment stability, especially in the absence of other forms o f unemployment benefits. Generally, severance pay i s considered one of 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, it distorts the behavior o f workers and firms, and it often leads to excessive litigation. There i s conclusive evidence that this form of labor protection has a negative effect on job creation (Heckman and Pages, 2000) and that reductions in severance pay generally favor more disadvantaged workers, like youth (Gill et al, 2001). However severance pay does have three strengths - it generally does not create an incentive to delay hture job search, it is easy to administer, and it pools employee risks at the firm level. Intrying 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 on 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 of unemployment spells, 72 inter-household transfers and other informal social protectionmechanisms, and the types o f employment shocks typically faced by workers inthe OECS, will informthe appropriate design o f necessary severance payment reform. At the minimumhowever, the OECS countries should consider reduction o f severance payment levels inline 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 restrictingthe use o f short term and temporary work contracts also results in lower employment rates, longer unemployment spells, greater informal employment and less job creation-with the key losers being women and youth. In other countries, liberalizing the use o f temporary contracts has, as expected, resulted intheir widespread use and has been accompanied by higher employee turnover, but it 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 of 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 morejob creation even at lower real wages. Inthe long run, greater wage competitiveness and employment flexibility will stimulate more investment and morejob creation. And a larger share o f formally employed workers will 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, includingthe employed and unemployed workers, inorder to be successful. 5. 60 In making the case for labor market reform, it will also be important to note that business regulation is neither an appropriate nor an effective tool for social protection. Box 5.4 notes the lessons learned by the Nordic countries inthis regard. BOX 5.4: SOCIAL PROTECTION REQUIRES MOREBUSINESSREGULATION. 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 renownedfor 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 theyfocus regulation on where it counts -protecting property rights andproviding social services. Estonia, Latvia and Lithuania, having leamed muchfiom 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 understandingthe 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 on the labor market. The OECS, and the wider Caribbean, have seen significant migration of skilled personnel beyond the region over the past two decades. Recent estimates based on overseas census data indicate that the stock of 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, it 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 intransferring skills and technology to the home country. Box 5.5 illustrates the positive impact return migrants can have on an economy. This may be even more important inthe 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 MIGRATIONINIRELANDAND 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 Ireland, software industries benefited fi translated these skills into a technical and engineering skills base t urning expatriates - had constituted the largest EU source of immigrants to the rnia) in the 1980s an many completed tertiary and acquired important skills in t uter and software industries. Source: de Ferranti et a1 (2003). 5. 62 A second impact of migrationon the labor market is through remittances. Remittances to the OECS averaged 5 percent of GDP in2003, 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 on 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 inparticularly lucrative sectors, tourism inneighboring islands and other migration opportunities. This has the impact of raising voluntary unemployment, but also maintaining a higher average wage than would be competitive. FIGURE 5.6: REMITTANCE FLOWS (Yoof GDP) - 14% --O-AntiguaandBarbuda -Dominica - 12% _ _ _ _ st. Kittsand Nevis 10% st. Lucia - St. Vincent and the Grenadines OECS 80x7 6Ox7 4% 2% Source: CARICOM and ECCB estimates. 5. 63 Finally, intra-regionalmigrationflows bothwithin the OECS and CARICOM, to date and in the future under the OECS Economic Unionand the CSME, ultimatelyhelp to fill unmet labor demand at boththe low and highends o fthe skill spectrum and to reduce wage pressures that negatively impact competitiveness. Infact, the OECS countries stand to benefit from the former impact more than the larger states because the small market size may make it more difficult to find specialized skills. 64 Upuntilrecently Dominica, Grenada and St. Vincent and the Grenadines operated economic citizenship programs through which personsundertaking a certain amount of investmentqualified 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 is far from seamless. Table 5.7 also illustrates the large variation in wage rates across the OECS countries. In addition, firms generally report paying around EC$250 per week for unskilled labor inthe 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,66the 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. 5.65 Under current agreements, the sub-region i s committed to free movement of labor only by 2007. Although some rules have been relaxed ina few countries, work permits are still required for most OECS nationals to 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. For example, in Antigua and Barbuda legislation requires the Minister o f Labor to personally sign each permit. This practice only serves to impede firms' abilities to find the specialized skills that they need to expand production andjobs 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 CSME protocol and reduce as much as possible regulatory constraints to the flow o f workers. 66Using purchasing power parity factors. 75 CHAPTER 6. TECHNOLOGY,FINANCEAND INFRASTRUCTURE A. Firmcapacity and technology adoption 6. 1 It has been well recognized that successful economies are built on successful firms. To improve the performance of an economy, one must improve the ability o f firms 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 we 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 on 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 on firm surveys in the OECS, and reports on 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 inprivate domestic investment over the same period. UsingGrenada 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 firms registered each year went from 14 to 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 firms or sole proprietorships. Among the relatively few firms that are incorporated, even fewer have outside independent investors. These firms 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 inprivate sector activity. Larger firms tend to be either foreign-owned or joint ventures between foreign firms and the Government, and the majority are to 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. Many reports posit that the size and informality o f firms inthe OECS limit their general capacity for innovation and, ultimately, competitiveness. However, Riddle (2002) shows that inthe service sector particularly, smallness i s not necessarily a hindranceto performance. She points to the existence o f numerous one- and two-person firms in Australia successfully exporting specialized expertise, and that according to the Australian Bureau o f Statistics data in 1997 service firms o f fewer than five employees frequently outperformed their larger counterparts on 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 to 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 agriculturalproduce as a way to capture an increased share o f the informal trade inthe sub-region. 6.6 Notwithstanding the above, a number of donor reports suggest weak managerial and business skills 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 inthe sub-region. For example, the Grenada survey revealedthat at least one third ofthe 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 199ff7reported the following management challenges: 0 a distinct lack o f awareness and expertise on the part o f owners/operators about product quality, marketplace expectations and standards; 0 one-third o f the sector appeared to be more interested in getting sales rather than operating their properties; 0 40 percent o f respondents, and 61 percent o f guesthouse operators, were unaware o f their market position. 0 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 0 more than one-third o f properties surveyed had not undertaken a re-pricing o f their accommodation services inthe last five years. 6. 7 The third feature worth noting i s that the sub-region does have a growing number of firms, entrepreneurs and investors that are gearing up for stiffer competition, both domestic and foreign, by improving product quality, customer relations and productivity. More than 60 percent o f the firms surveyed in Grenada reported having taken some initiatives over the last three years in order to 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 existingproduct line and the introduction o f a new technology that changed the way their main product was produced. The median amount o f investment inproduct and technology upgrading over the last 12 months was 78 percent o f net profit, with close to a quarter o f the firms 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 INNOVATIVEACTIVITY UNDERTAKENBYFIRMSINGRENADA OF Upgraded an 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 10 20 30 40 50 60 %offirms insample Source: World Bank (2004e). 67 OAS Small Tourism Enterprises Project. 77 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 firms that were interviewed throughout the sub-region indicated that this was their first line o f defense from competition. While it did not appear to detract from their awareness o f the need to 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 firms 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 Upgrade new product product Source: WorldBank(2004b). 6. 9 Therefore, the challenge inthe OECS with regardto firms 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 needto 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) Buildingprivatesectorcapacity. 6. 10 In recognition of 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 firms -a recent DFIDreport6'identified28 programs-but few that have a specific firm-level focus. This report identified eight sub-regional programs inthe 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. Inaddition, 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 donor- financed programs. At the country level, St. Lucia recently launched the National IT Fund which provides assistance to IT firms 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 `*DFIDLaw andDevelopmentPartnership(2002). 78 businesses. Dominicabenefits from DFID's Fiscal and Economic Recovery Programwhich has a private sector development component but this focuses primarily on 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 Agriculture, 4 Mainly industry-wide .i 4 Program for Tourism, Credit training programs offered Economic Unions, through govt agencies and Competitiveness Construction trade associations Direct assistance to credit unions through their regional association, and to 16 manufacturing firms 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 be 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 its impact in terms o f concrete business outputs - sales, employment, exports, although the OECS EDU has conducted an important client satisfaction survey among the beneficiaries. Finally, several o f these program managers acknowledgedthat the models they use are based primarily on merchandise exports and need to be adapted to 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 inthe 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 firms for capacity building.69 The programprovides 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 inknowledge. Examples of such interventions would include funding feasibility studies, providing information on 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 from entertaining rent-seeking behavior on 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 industryclusters, 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 on 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 on developing markets for services, first by understanding the existing market including firms' willingness-to-pay, and the underlying reasons why these services may not be currently available from the private sector. For example, firms tend to rely on inter-firm relationships and informal sources of information and assistance, Supply-side interventions, such as training to service providers can be used to extend models of financially sustainable, cost effective services, while demand-side interventions, such as matching grants and vouchers, may be justified on a temporary basis, because firms 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. 69 Other prongs include assistance to private sector organizations, strengthening parastatal organizations, policy formulation, strengthening capacity and coordination at the ministry level, and entrepreneurial skills development at the community level. 70 Additional information on this topic can be found o n the Access to Business Services Network of the world Bank's SME Development Program at http://www2.ifc. org/sme/htmI/capacity_bIdgJacility. html, as well as the Committee o f Donor Agencies for Small Enterprise Development at www.sedonors.org which has published BDS Guidelines. 71Webster (2004) and Hallberg (2000). 80 FIGURE6.3: PROVIDINGBUSINESSDEVELOPMENT SERVICES The Old Approach: Substitutefor theMarket -----------I I Private- I Governmentagency, Directprovisionof services The New Approach: FacilitateMarket Development I Firm Firm L I ' Firm Firm Public funding, development Privatepayment, commercialorientation Directprovisionof services ----b Facilitationofdemand&supply Source: Committee of Donor Agencies on Small Enterprise Development (2001). 6. 15 Small market size may hinder the development of private business development service providers locally. Although very little work has been done on 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 firms 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 well as improvements infirm level access to ICT services. Inlight of 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 inways that may help to develop local capacity while maintaining competition and access. 6. 16 Industry clusters provide an important avenue for the formal and informal interaction among firms that is a critical element in the diffusion of learning and technology. While current research i s still unclear as to whether there i s a role for government inthe emergence o f industry clusters, evidence does indicate that public support for technological development o f firms i s best provided through these groupings. 6. 17 In 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 mentionedprograms offered by the CaribbeanTourism Organization and the Caribbean Hotel Association. Box 6.1 describes another such program managed by the Jamaica Exporters Association. Inthis regard, it i s important to note that efforts by OECS EDUto develop an Association of Eastern Caribbean Exporters which could spearhead such an effort inthe sub-region has not yet proven successful. 81 Jamaica. A joint purchasing program in agribusiness, which resulted in a projected US$l million annual savingsfor 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 already beenformed betweenJamaican s and North American andAfi-ican distributors. 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 theprivate 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 nextphase willfurther develop local capacity as well as move toward sel$funding by theprivate sector andparticipants. 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 inproviding access to finance to SMEs, they can be a potent mechanism for intermediatingventure capital and establishing networks o f investors. The goal o f an incubator i s to nurture new enterprises intheir most vulnerable phase untilthey "graduate"-that is, they are financially viable and freestanding to leave the incubator. To do so, incubators impose stringent selection criteria upon prospective firms, and monitor firms' development with clear performance metrics and on 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 job 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 inthe client companies inexchange for supplyingoffice space and services. Research by the U.S. National Business Incubation Association (NEUA)72indicates that publicly-supportedincubators createjobs at a muchlower cost that other publicly- supported job creation mechanisms and that business incubators generally reduce the risk o f small business failure. Members o f the MIA report that more than 80 percent o f the companies that graduate are still inbusiness after two years. 6.20 A recent development in this area is the creation of "virtual" incubators, currently underway inItaly. These incubators put a strong emphasis on internationallinkages. The incubators act as clearing houses to link up the client firms with managerial expertise, finance, and technology from anywhere around the world. The creation o f such incubators relies heavily on available and affordable information technology services. 6. 21 Key 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 illustratedinthe experience o f the Technology Innovation Center inJamaica, described ~~ 72 InfoDev (2005). 82 inBox 6.2. Inparticular, any efforts on the part of the incubator to intermediate finance for its clients should be clearly separated from the day-to-day operations and financial management o f the incubator itself. Box6.2: JAMAICA'STECHNOLOGY INNOVATION CENTER(TIC) I n 2002 the University of eurial Center in Kingston. At t mmunicationfacilities and tec te, TIChas approxima an incubator manager, an information systems and marketing oflcer, bator is overseen by a Management Board chaired by member of the private sector. The to Jamaica, CIDA and own revenue generating activities. The latter comprising rent and tenantfees, and consulting and trainingprograms offered to theprivate andpublic sector that represent 50 to 60percent of the budget. TIC 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 withfirms developing Internet-based technology and customized computer software. One client is in quality control and another in commercial mediaproductions. The largest firm has I7full-time employees and 2-3 owners and the smallest one 1-2 employees. Their client base is quite mixed- they 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 establishedjoint 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. TIC usually facilitates this process by providing technical assistance in drafting businessplans 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 senior manager, this scree ' t as basis for choosing Currently TIC is also t s gain access tofunds. This growth investment fu t of high net worth individuals that want to provide seed capital to emerging companies. /Canadian billionaire, Michael Lee Chin has recently pledged a US$I 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. Sofar, only one incubator client dedicated to commercial media production has been able to secure a total of JA$4 million infinancing through this scheme. Companies "graduate when they transitionfFom being start ups to anchors; however, the incubator does not have I' precise benchmarks or criteriafor how the transition takesplace. Current Challenges As suggested by the center's Senior Management, the challengesfaced by the TICfall infour 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 afund set up by thir investment network. 2. Adapting to changing llenge for TIC is to adapt tht incubator's technology since the incubator is very heavilj other profitable complementag bator becomes widely publicized Source: InfoDev (2005). 83 6.22 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 inde 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 by whether a country i s adopting, adapting or inventing new technologies. In each phase, there are appropriate public sector policies. 6. 24 InPhase 1countries transit up the technology ladder by plugginginto the global knowledge stock and adopting technologies that have been developed elsewhere. This is achieved mainly through trade, FDIand 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 ICT 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. Service- related FDI such as i s common in the OECS i s characterized as being at the low 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 firms can mimic. For example, the former manager of a foreign owned hotel may go to work (or start her own) hotel usingsome o f the techniques she learned on 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 on the capacity o f local firms 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 is by far the most important mechanism, followed by 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 inAntigua and Barbuda. Mountaintop Inc, a bottled water company in St. Vincent and the Grenadines, was one o f the first o f these firms in the Caribbean to purchase its own 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 inMiami, each time the machine broke down. So the manager and his staff basically reverse-engineered the machine. While this was a painfil process, the staff have now become so proficient that the Miami 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 firms in the sub-region have been started by returning immigrants with key skills, such as Benjo's SeaMoss inDominica and Barrons in St. Lucia which were started by food scientists, other firms have had to hire needed expertise, such as Galeforce Windows in Antigua and Barbuda which hired a polymer scientist from the UK to runits operations. 73Xu (2000) andBorzensztein, de Gregorio andLee (1998). 84 FIGURE 6.4: HOWFIRMSINGRENADA INNOVATE Others Developedwithin Embodiedin new establishment equipment 45% international sources Trade FairdStudy Tours By hiringkey 10% personnel 10% Source: World Bank (2004e). 6.27 In Phase I1of the technology ladder, countries have reached a minimum adequate level of 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 with linkages to the private sector. Mobility o f labor between firms and pure research bodies i s increasingly important. The role o f government may 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 inthe production o f R&D. InPhase 111, countries have become technological leaders where firms make large investments in R&D to create new products and processes. Evidence from the Grenada survey indicates that actual firm expenditure on R&D inthe OECS is very limited, incontrast to the measures to import technology common inPhase I. Only eight companies indicated that they had spent money on R&D activities in2003 (three intourism, two 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. It i s unlikely that the OECS with its small population size could support the development o f such systems even within its major sectors. As such, the sub-region should focus on improving the enabling environment (required even for Phase I) and should rely heavily on integrating its firms 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 CARICOM and the University o f the West Indies. However, one key lesson from the Latin American experience i s that universities and research institutions without sufficient and sustained linkages with private business needs do not really affect internationalcompetitiveness. D e Ferranti et a1(2003) point to the fundamental differences inthe approach to higher education inthe US, where in 1919 MIT launched its Cooperative Course where students spent half 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 its firms and these research institutions, as well as focus on how these systems can help innovation inthose industryclusters, such as tourism and certain niche products, that are important to the sub-region. 85 (ii) A case study on how ICTs canhelpbuildfirm 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. ICT can help firms to learn, market, and sell more effectively. However, realizing the promise o f ICT requires not only the adoption o f ICT, but its appropriate use. These examples highlight five opportunities in the OECS for using ICT to improving firm level productivity in key sectors, some of the lessons learned from actual firm and cluster experiences, and identifies recommendations for moving forward the use o f I C T inthe sub-region for this purpose. 0 Communicate with customers and integrate forward. Properly executed business strategy starts with the customers' needs. Successful firms are able to identify demanding and underserved markets and develop methods to effectively service those customers. Firmscompete 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 to 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 low cost models, such as the all inclusive or enclave tourism, countries needto 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 andfood snacks in St. Vincent and the Grenadines, which employs 10persons andpurchasesfrom more than 200farmers island-wide. With annual sales of US$200,000, they originally marketed their goods mainly in the Caribbean. The company has been able to benefitfrom 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 ordersfrom the USmarket, which now accountfor 10percent of revenues. Thisgrowth hasprompted the company topartner with a USdistributor 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 aimed at developing an alternati tourist market. Members include a IO-room eco- retreat, a tour operator withfour ur. Theprimary goal was to unite cluster members in customer and marketing alliances that would allow them to compete for high-paying visitors. Members came together toproduce custom tourpackages 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 ICT 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 better experience, but have an accura 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 the effort was more ticipated. Bermuda Escapes learned 74 This section is based entirely on a report preparedby 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 assistedby 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 thesepoints are about issues of culture and trust. Thefirst lesson was not to underestimate the investment required . Whiletheprofessional information and tyin second lesson was the need to enforce punishments for not adhering to the system.Atfirst, 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. ICT 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. Inagriculture, where most o f the players are small and fragmented, there i s an important benefit to eliminating information asymmetries. able toprovide immediatepricing 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. Theplant 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 if it were done manually. The company pays twice th inimum wagefor factory workers, employs young operators and invests heavily in specialized training, which h onsiderably reduced turnover rates. As business grows and reueat customers are the norm, online transactions may become a viable option. 0 Make 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 still gave the edge to local firms. The advent o f global ICT has made it easier and cheaper than ever to stay intouch with customers and suppliers, and as knowledge and information become an increasing percentage o f the `value-add' o f products, ICT creates significant value by allowing the free and instant transport o f digitized knowledge and information. Although popular examples o f ICT overcoming distance are often those o f international coordination o f production, or the ability to communicate with customers half 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 on its way to shore using a cell phone to learn which harbors are offering better prices, or which markets have greater demand for the types of fish inthe 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 provides a range of services to ultrasounds and mammography medical imaging. As the sole radiology provider in St. Vinc nd opinions or the judgment of medical specialists in some rocedure of sending hard copies to colleges around the world. was incorporated in the practice as a way to improve diagnosis a the Center started using digital cameras to upload i volume of data transmitted also made the process significantly long. With the advent of Digital Subscriber Lines (DSL), transmitting was made virtually instantaneous and of superior quality. In fact, CMIC 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 andprovide maintenance to the equipment remains aproblem, as is the absence of aformal structurefor 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 no longer confined to the neighbouringplantations, mines and factories, today's companies need to compete with global firms 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 firms o f all sizes gather customer and competitor information inreal time allowing them to make timely and informed decisions about how and where to compete. Jamaica Signature Beats (JSB) is a non-profit company of music producers, studios andprofessionals which have joinedforces toprovide technical and creative expertise to the international music industry. The company usedICT to access information and online surveys to in ional labels to reposition themselves andfind customers around the world that would be interested in record Jamaica. Jamaica remains an attractive location because of 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 apublic relations campaign by electronically distributing its press release to over IO0 USprint 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. Theyprovide randomized surveys to track customer satisfaction to make sure that producers and studios are on time, fulfill their cont clients. I t is important to note that the collaboration around th of low trust, communication and collaboration within the indus had made interactions with the global music industry quite dgficult. 6. 30 Recommendations. The following are a number o f recommendations for the public sector and donor community on how to promote the use of ICT by firms to buildcompetitiveness: 0 Facilitate access. Access to technology, as seen above, i s essential for firms 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 inmobile telephony, but the process needs to be sped up and in parallel, new technologies like Wi-Fi or Wi-Max (longer-range wireless technology) need to be encouraged and widely embraced. Further details on access are presented inCh. 6, SectionC. 0 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 its use. The legal enforcement o f electronic documents and contracts, protection of 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 this realm. Laws on intellectual property as it relates to the internet -incode, data, music or other content - has important implications for businesses selling into a multi- jurisdictional 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 inthese reforms as a regional block. Norway has been at theforefront 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 Agencyfor Development (NORAD) inpartnership with UNDP,Norway is sharing its initial success with developing countries. I n addition, organizations like Internet Corporation For Assigned Names and Numbers and ITUcanprovide guidance on the latest standards. 88 0 Improve skills and capacity. As noted above, the skill 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 certificationto work with 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, it i s notjust the IT skills that count. The general level o f education and technology training o f an organization's employees i s a factor in any firms' ability to adopt any new technologies. In addition, appropriate managerial, marketing and research skills are needed for firms to understand the potential offered by ICT and therefore be more willing to pay for its 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 formulate national training policies and programs inICT- critical areas; 0 reform curriculum at all levels o f education and training to include ICT-critical areas; 0 develop programs for training on market research& data collection systems; and 0 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 trainingprograms of IT companies, as well as computer trainingfor unemployed secondary school graduates. Interest-bearing loans are provided for up to US$6,000per person with maturities ranging 12-48 months. TABLE 6.2: NOVELL CERTIFICATIONINTHE CARIBBEAN Numberofpeople with Novellcertified workers Novell certification per 10,000 people Antigua and Barbuda 2 0.255 Dominica 0 0.000 Grenada 4 0.382 St. Kitts and Nevis 0 0.000 St. Lucia 6 0.374 St. Vincent and the Grenadines 6 0.550 OECS 18 0.315 Cayman Islands 39 10.000 Barbados 84 3.123 Bahamas 82 2.611 Trinidad and Tobago 154 1.181 U.S.Virgin Islands 11 1.ooo Martinique 36 0.838 Belize 9 0.356 Jamaica 84 0.321 Suriname 13 0.300 Guadeloupe 13 0.292 Guyana 13 0.170 Source: Novell. 0 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, it 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 on lobbying for ''Datafor 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 ICT to build competitiveness and needto be encouraged. coop (processing, composting, packaging, financing, R&D). Bay oil isproduced by distillation from the leaves and young wood of aplant (Pimenta Acris) that is indigenous to Dominica. The oil is exported andfurther 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. Members own and operate 35 ries of an ancient type; the coop owns and operates one new distillery unit, vastly superior in eflc and in output capacity. Management of the coop is well-structured and has nds. They have ambitiousplansfor expansionfollowing from a well crajied strategy They are seeking to invest in added allow not only expansion of bay-oil output and 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 theprice 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" products (value added is estimated to be twice the price of non-orga roducts), using asfertilizer the compost producedfi-om by-products of disti Theplanning process is nowfar 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 reservesfor 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 firms away from 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 constrains economic growth. 'I Deloitte Touche Tohmatsu (2004). 6. 31 This section explores broadtrends infinancial intermediationinthe 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 main avenue o f financial intermediation. A large body o f analytical work has been done on the stability o f the OECS financial sector in recent years, which will not be repeated here. Despite the deteriorating risk 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. Inrecent years, bank lending to 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 innet foreign assets. 90 6. 32 Yet it 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 risky new ventures, and that instead these enterprises need risk or other forms o f equity capital. As i s common indeveloping countries the equity markets inthe 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, this 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 on 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 OECS 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 firms surveyed in Grenada relied exclusively on retained earnings to finance working capital with 19 percent relying exclusively on this source for new investment capital. The second major source of financing for the Grenadian firms i s bank credit. Venture capital and equity reportedly account for only 2 percent o f finance for new investments inGrenada. TABLE6.3: SOURCESOFFINANCE FIRMSINGRENADA FOR Retained Bank Trade Venture Other All Other Earnings Credit Credit Capital Equity Sources Working Capital Average share intotal finance (%) 60.2 25.5 4.5 1.8 1.5 8.2 No. firms accessing the source 111 68 28 3 9 36 No. firms relying o n the source entirely 45 8 0 2 1 1 New Investment Average share intotal financing (%) 48.4 42.0 0.4 0.8 2.1 6.4 No. firms accessing the source 51 41 2 1 3 11 No. firms relying o n the source entirely 25 17 0 0 1 2 Note: Total number o f respondents was 131. Source: World Bank (2004e). 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 firms in the OECS) found that the majority o f financial managers prefer to rely on 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 reportedthat maintaining financial independence was a preferred goal intheir financial planning ranking higher even than the goal o f maximizing firmvalue. 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 inthe 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 highinterest rates. Conversely, the banking sector cites a shortage of bankable projects, deteriorating creditworthiness o f commercial borrowers, and problems with realizingcollateral inthe 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 still remained robust at 8 percent per year during2000-2003, even inthe face o f the recent deteriorating risk profile o f the banking sector. Part o f the reason for this ~ 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, with per capita consumer lendingrelatively highat 120percent of 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 from 13 percent in2000 to 20 percent in2004. FIGURE6.5: DISTRIBUTIONOFBANKINGSECTORLOANS ADVANCES BORROWER AND BY 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 SME business. 6. 39 In terms of credit instruments, the sub-region appears to be reasonably well supplied with both short and long term 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 still not readily available. The ECCB does provide an Import-Export Guarantee Scheme, but firms report that it i s burdensome inpart because it requires a separate application for each shipment. There are some efforts underway to expand this to include export credit insurance. 6. 40 Prime lending rates range from 8 to 12 percent, and have remained at this level since the early 1990s. Maximum lending rates remained high at 28 percent throughout the 1990s but have since declined to 25 percent in 2004. The reasons for these relatively highinterest rates have been explored in ,recent literature on the sub-region. Randall (1998) finds that the floor on deposit rates adds significantly 77 Includes mortgages. 78This may be a concern given that prudentialnorms would require not more than 25 percent o f a bank's portfolio in one sector. Moreover, the prevalence of natural disasters together with l o w levels o f private insurance make this an even more risky scenario. 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 recommendationthat an in-depth analysis be undertaken to determine the net effect o f the deposit interest rate floor on 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 firms 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 firms 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 reportedby many banks inrealizing collateral inthe event o f default. 6. 42 On the demand side, there is 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 half o f the companies in the Grenada firm survey that reported using overdraft facilities or lines of credit were using less than 50 percent o f the approved limits 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. Inaddition, several firms that were interviewed noted that national development banks were not offering muchmore than commercial banks. 6. 43 In 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 to strengthen financial intermediation through the banking sector. These include: 0 raise accounting standards to increase the supply of appropriate financial information by borrowers for lending; 0 introduce a credit bureau inthe OECSS0to provide greater information on borrower riskprofiles; 0 encourage consolidation o f the banking sector to create the economies o f scale needed to reduce operating costs; and 0 address the legal and administrativeissues 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 its diversification and growth, for two reasons. The first is 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 inthe OECS are changing, and indeed will continue to change, as the sub-region transforms and diversifies the structure o f its economy and export base. Table 6.4 presents a textbook check list for firm financing decisions. In general, credit i s preferredhecommended when firms are operating in a stable economic climate, have a relatively low 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 to be accelerated, can be characterized as a period of Schumpeterian creative-destruction inwhich there will be enormous churning as firms seek out new and profitable ventures inan evolving external environment. 6.45 In addition, service firms have different financing needs and borrowing capacities than brick and mortar, or agricultural operations. For example, they may have less fixed assets to serve as 79IMF(2003a). A Barbadian firm has recently completed the feasibility for a regionalcredit 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 firms 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 managedto sustain these types o f markets. TABLE6.4: A TEXTBOOK CHECKLIST FORFIRMFINANCING DECISIONS NEWINVESTMENTS FOR I I I Debt is preferredwhen the firm has: I Equityis preferredwhen the firm has: A more stable sales forecast I __ Riskier sales when branching into new areas _ _ _ I Profitability A more stable outlook for profitability Riskier butpotentially highrates o freturn Asset structure An adequate amount o fgeneral purpose fixed - - - Business specific assets that may be assets difficult to-resell inthe event o f a default Leverage L o w enough operating leverage to allow for Reached some limits o n its borrowing hrther borrowing capacity Taxes Higher tax rates that allow interest expense Growthrate Rapid, but certain growth rates Rapid, but more uncertain growth projections Lender attitudes General agreement with its lenders on its Less agreement with its lenders on its appropriate capital structure appropriate capital structure, perhaps because it is entering a field inwhich the lender has less familiarity and expertise Credit conditions Good market conditions for credit, including l o w interestrates Internal Achieved some new operational goal such as Achieved some new operational goal such conditions product development or improved efficiency as product development or improved that may not be well understood by creditors efficiency that may not be well understood by investors or the stock market 6. 46 To 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 its 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 firms which may be 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 firms to access this form o f financial intermediation. Given progress on the CSME, there will likely be pressure in the future to merge or integrate the ECSE with other stock exchangesg1inthe region. 6.47 Inthe middle of the equity market spectrum, the OECS is served by a few fledgling venture capital institutions and a new regional private equity fund inTrinidad and Tobago. This segment o f the equity market i s characterized by private institutions that are organized to connect investors with enterprises in a less organized fashion than public equity markets, but they play a crucial role in match- making 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 establishedby the ECCBis intendedto provide another participant inthis 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, BarbadosandTrinidadandTobago. 82For recent developments see The Economist (2004). 83 ECCB (2004). 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, from 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 capitalbusiness model is low 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 on the exchange. SME/micro finance i s a lower cost, highvolume business requirement with some degree o f systematization closer innature 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 on 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 is 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 inthe OECS such as buildingtrust outside ethnic and family groupings, building technical expertise at the enterprise level, promoting relevant banking and accounting services, trail-blazing with regulatory and legal authorities to develop new equity and quasi-equity instruments, and limited exit strategies for the investors. As such, the sub- region should seek technical assistance to re-examine and, if necessary, reformulate the ECEF proposal before proceeding. 6. 50 Finally, at the least organized end of equity markets are the most idiosyncratic mechanisms connecting investors with enterprises. They range from entrepreneurs simply reaching out to 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 still faces critical cultural barriers to the dilution o f ownership and control involved in taking on outside investors. Very few o f the small firms 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 its financial advisers from taking on new investors to finance the much needed development o f a small plant. At the same time, however, when this option was raised for one small exporter during a meeting in Dominica, at least one o f the larger (and currently protected) manufacturing firms jumped at the idea o f investing inthis firm as a means o f diversifying its 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 firms 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 In 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 firms are businesses which support one or more families, but do not have realistic prospects to become publicly listed companies. 86Not including Nigeria, South Africa, Zimbabwe, Cameroon, Kenya, Sudan, and C6te d'Ivoire. 95 C. Telecoms, energy and transport 6. 52 The OECS 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 inthe 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 inthe 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 still engender natural monopolies in this part o f the national supply chain. In some areas, new technologies have reduced the minimumefficient scale of utility operators to such an extent as to pave the way for private competition, both domestic and foreign, even in such small markets. Inothers, new advances may 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 of the scale disadvantages. 6. 54 With relatively good levels of access to utilityservices by the general population, the OECS 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 well as indirectly by affecting the productivity o f a country's human resources. For example, poor access to clean water and sewerage will affect health outcomes and inturn labor productivity. School children with access to electricity - or, on another dimension, the internet - will be better prepared for the labor market. As such, there are often tradeoffs to be 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 interms 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 In many cases the pricing of services still reflects the historical policies of redistribution aimed at achieving equitable growth, but resulting in a bias toward consumption and away from production, While it remains a common practiceworldwide 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 inthe OECS i s significant. Any agenda for growth will necessitate some rebalancing o f these transfers in order to reduce costs to the private sector as the engine o f growth andjob 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 inthe OECS. Despite recent advances inthis area, with the establishment of the Eastern Caribbean Telecommunications Authority and the successful dismantling o f the sub-regional monopoly in some key areas, the OECS will 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 on firms, households and the government. 6. 57 Teledensity in the OECS 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 much 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 inthe 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 on average by 53 percent per year during 2000- 2002, remained well 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 its subscribers alone in Grenada, St. Lucia, and St. Vincent and the Grenadines inM a y 2004 are more than double the total number o f subscribers inthose countries in2002. 6. 59 Fixed telephony costs for connections and monthly subscriptions as reported to the International TelecommunicationUnion 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 well with its competitors on residential charges, again reflecting the regional tradition o f striving for equitable access, but less so on the business charges. Unit charges for local calls and intemational calls inthe OECS are higher than its 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: SELECTEDTELECOM AND ICTINDICATORS, 2002 ResidentialCharges BusinessCharges Cost of a 3-min call Internet users US$ Connection Subscription Connection Subscription to NYC Local per 100 people OECS 59 8 70 18 1.36 0.09 13 Caribbean 45 7 49 19 0.91 0.04 13 Americas 88 8 115 16 0.65 0.05 10 Other micro states 61 11 64 18 1.60 0.07 21 Upper middle income 62 8 82 12 1.01 0.09 14 USA 23 428' 72 44 55 Source: World Bank (2004i), International Telecommunications Union (October 2004), and InfoDev (2004). 6. 60 Small states face major cost disadvantages with respect to international calling charges, but an 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, on the order o f 20 percent for monthly subscriptions or line rental rates in microstates." Onthe other hand, they find very significant and major cost disadvantages with respect to per unit intemational calling charges, on 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 from 6 users per 100 persons inSt. Vincent and the Grenadines to 21 users in St. Kitts and Nevis. However, the sub-region will need to broaden access significantly if it hopes to use the internet as a means o f raising competitiveness. "Highsubscriptionchargesmayreflectrelativelylowerunitcallchargesbecauseoftheplansofferedbyproviders. 88Winters and Martins use a definition for microstates of having populations less than 400,000 persons. 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). Inrelation to GDP, we see that the OECS has the following average number of 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 inbelow the mean. It i s also notable here that the best performers with respect to their economic size are generally small countries, again implyingthat the internet provides a wayto overcome other scale disadvantages. FIGURE 6.6: INTERNET HOSTS, 2002 18 Taiwan, Prov. of China 8 0 0 6 o / 0 lcelang o 0 0 0 16 18 20 22 24 26 28 30 Log GDP (US$) Source: ITU(2003). 6. 63 Commercial internet access in the OECS 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 on 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 US. 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 inWestern 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 on 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 still a bit higher than, say, Mauritius which has the same costs as the US at $15. The above analysis points to the recurring theme that, ingeneral, businesses face greater disadvantages in the OECS vis-a-vis their international competitors than do private consumers. ~ 89 A type o f highspeed Internet connection that provides a great deal o f bandwith. Many businesses lease T1 lines, but they are generally expensive and offer more bandwith than most small businesses andhomes need. 98 TABLE6.6: IMPACT OFLIBERALIZATIONTHE OECSTELECOM ON SECTOR No. of telecomfirms' Employees Investment (EC$m) Pre-liberalization, 2001 12 841 90.3 (2000-01) Post-liberalization, actualand 24 1,771 165.7 planned for 2002-2004 (includes licensedfirms who are aboutto start operations) 1 includesincumbent, fixed, mobile, IT, Intemet, and CableTV 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 inthe sector (see Table 6.6). Average prices for calls from 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 main land line 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 is the sequencing of future reform efforts in the short term 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 now having high teledensity still suffer from highcost 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 skills i s a key factor constraining business development and competitiveness and internet access in schools and homes can be an important factor inraising both the quality o f public education, and private investments indistance 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 work 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 by many of the firms interviewed for this report. Figure 6.7 illustrates the relatively higher costs which plague the sub-region in comparisonto the rest o f the Caribbean. As well, insome countries, inparticular Antigua and Barbuda, Grenada and St. Kitts and Nevis, there are significant shortages in capacity resulting in periodic power cuts and brown outs. Ina survey o f 24 exporting firms undertaken for the OECS Export Development Unit, `electricity supplied by local utilities' was ranked as the second biggest problem." Inthe Grenada investment climate survey (see Annex l),was ranked as the most severe it infrastructure-related problem with 13 percent o f the firms 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. 90Madsen(2004). 99 FIGURE6.7: ELECTRICITYCOSTS 30 Source: Castalia (2004). 6. 67 Electricity costs are driven primarily by four factors: (i) of primary energy used to generate costs 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 of the utilities in the OECS rely exclusively on diesel fuel to run generators. It 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 betweenUS$0.02 and US$O.OS per kwh. TABLE6.7: ELECTRICITYPRODUCTIONANDPRICING St. Vincent Antigua and the and St. Grenadi Barbuda Dominica Grenada St .Kith Nevis Lucia nes Baseline Electricity Rate (US#/kWh) Residential 15 21 14 12 19 12 16 Commercial 17 26 16 16 19 17 18 Affordability (monthly medium household bill for 280kWh, no service charge, as % of GDP per capita) 0.4 1.9 0.9 0.5 0.7 0.8 1.5 Electricity production (bWh) 178 80 153 121 288 99 Total installed generation capacity (MW) 50 20 40 19 9 66 28 Hydropower (% total production) - 45 - - - - 19 Transmission & distribution losses (% total output) 11 19 14 13 11 Employees per 1000 connections 11 8 6 5 8 Nevis i s listed separately because it has its own electricity company which is 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. It i s important to note that the two countries with significant hydro generation - Dominica with 45 percent and St. Vincent and the Grenadines with 19 percent - also have the highest cost systems inthe 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 invery small systems. Inthe OECS, installedcapacity ranges from 9 megawatts (MW) in Nevis to 66 MW 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 intechnology with smaller plants nowbeingmade infactories, rather than constructed on site, have greatly reduced fixed cost o f construction and installation. For example, new diesel generator units are now available as small as 1MW incapacity. Above a few MW, there appear to be economies o f scale inthe 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 will be unavoidably higher than ina 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 to purchase, they are less fuel efficient than their medium sized counterparts. But larger units operating below their optimal load will also tend to have lower fuel efficiency. Companies may also view buyinglarger units less often as a way to reduce the disruption created by construction, even if this i s minimized by completing the civil 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 existingplants increases margin requirement. 6. 72 In the OECS, there is 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 New Zealand are two countries in which losses are considered close to being optimal.94 They are 4 and 11percent o f total amount generated, respectively. Inthe OECS, they rangefrom 11percent inAntigua andBarbudaand St. Vincent andthe Grenadinesto 19 percent inDominica, which are considered quite highfor small dense systems. Inone case, however, instead of implementing the low 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 of the utilities can help to reduce costs and prices. 6. 74 In the OECS, it is still common to find both subsidies and transfers in electricity pricing. These are generally intended to provide consumers with low 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 is important to note that the second largest system in the OECS is inAntigua and Barbuda with the fourth smallest population. 92The unit capital cost for 5 MW is 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 will cost xo,86 times as much. 93 The Antigua Public Utilities Authority which owns distribution network, purchases power from a private generator. 94Optimal losses dependon 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. To 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 In 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 small household and commercial customers. The reasons are easy to grasp: (i) billing and metering costs 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 inthe 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 on competitiveness o f the sector. As a result, non-utility and self generators are already quite common inthe islands, making regulation and management o f the system more complex. BOX 6.3: ELECTRICITYCROSS-SUBSIDIESINDOMINICA Under the current system of electricity pricing in Dominica (as of November 2004), the extent of the subsidies ranges between 15-50percentfor 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 60-80percent of all users, the industrial firms who wouldfinance the transfers are fm, 10-15, in numbers. One way to reduce these subsidies and to make them more transparent is byfirst reallocating costs by bothfunctional and customer categories. For 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 befollowed by a gradual adjustment of the tariff regime to reflect these costs in the charges for each customer class, while retaining the subsidized lifeline ratesfor thepoorest users. 6. 77 In general, weak oversight and regulation of the electricity sector in the OECS has further exacerbated the situation, and not protected consumers -both residentialand 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 still abound because o f generation and/or distribution constraints. InDominica and St. Lucia, which 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 its ongoing regulatory reform Dominica's legal framework provided the utility operation with a 15 percent retum by way o f automatic tariff adjustments based on an almost complete pass-through of costs. Ineffect, this regime provided no pragmatic incentives to the utility company to improve efficiency and effectiveness and reduce costs inthe long run. 6. 78 Reforms are needed in both operation and oversight o f electricity companies, as well as in pricing, The above analysis shows that the sub-region needs to reduce costs and improve supply o f electricity to improve competitiveness inits key sectors. Inorder to do so, the sub-region should: 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 ECTELwhich oversees the companies ineach member country. 0 Pursue greater private participation in ownership or operations. It i s important to note that this option may not be viable for the very small utilities. Even if the state remains the owner o f the local utility which may be too small to attract private participation, the arms-length nature o f a regional regulator would help to insulate governments from the political pressures that are 102 common in electricity issues and that canjeopardize good management o f these critical elements o f domestic infrastructure. 0 Regularly undertake a regional and international benchmarking of the electricity utilities. This would 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 inthis 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 petroleummarkets are characterized by very small import volumes -the entire sub-region importslessthanatanker pershipment-anda smallnumber ofimporterswho 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 to 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 internationalbest practices. The following analysis presents some o f the measures and how they.mightbe adapted for. These practices cover issues such as pricing, supply, infrastructure, transport and distribution. 6. 80 In terms of pricing, the current standard is 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, on a cargo-by-cargo basis, international oil 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 on common operating margins which are negotiated with industry operators on a periodic basis. Price changes are automatic and based on a predetermined periodicity. This system prevents cartel pricing within the local sector and provides for competition among industryoperators -wholesalers and retailers -based on efficiency gains and service quality. 6. 81 Except for Dominica, all the OECS countries currently set retail prices for petroleum products on 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 inthe local market as well as revenue instability. In2001, St. Lucia announced its intention to fix the tax and periodically adjust retail prices inline with internationalprices, but has only done so on a sporadic basis. Box 6.4 below shows the costs o f this approach. BOX 6.4: THECOST OF PRICE CONTROLSINTHE PETROLEUM SECTOR ''In St. Lucia, where theprice of gas at thepump still stands at EC$7.75per gallon, the government has shieldedI million. However, ocketing at an unbridled pace, have resulted in pressur were more stable. Source: Government of St. Lucia (2004). 103 6. 82 Some countries have established a system inwhich national supplies are procured jointly by private importers to save costs. In a number o f countries, notably Kenya, Tanzania and Ghana, national petroleum imports are procuredjointly by private importers using a system o f international competitive bidding (ICB) for imports. The large volumes and the ICB process generally result inlower prices, and prevent unfair transfer pricing by importers who are affiliated with supplying refineries. However, the system requires a heavy and often complex administrative apparatus which i s run and paid for by the importers, while the government's role i s limited to oversight. In considering such an option, the OECS countries would have to take into account the very small regional andor national import volumes and limited domestic capacity o f importing companies. Attempts by governments to manage and implement this joint procurement have been universally ineffective and not tran~parent.~~ 6. 83 The OECS should work to eliminate the current use of an antiquated Caribbean postingsg6 system established in the 1950s in which the border price of petroleum imports i s based on quotations by oil companies (several o f which no longer supply the sub-region). Instead, the pricing o f petroleum imports into the sub-region should reflect international spot market prices, as it does inover 90 percent o f global oil trade. Using such an international spot market benchmark, such as U S Gulf Coast Spot adjusted for ocean freight netback and small cargo sizes, could reduce import costs inthe OECS by aroundUS$S/gal for motor gasoline and US63 for diesel and kerosene. 6. 84 The 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 CARICOM Task Force on Energy was formed in 2004 to approach Trinidad and Tobago on 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 on a range o f issues, but which should also include the issue o f these postings. 6. 85 In some OECS countries there is an excess capacity of storage, transportation and distribution infrastructure that raises the retail costs for petroleum products. This situation occurs when individual importers establish their own storage depots and their own 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 in2002 was 200,000 imp gal, which i s very low even for developing countries with small markets. This situationi s often caused by setting operating margins too highso that there are excess returns to these operators. While it 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 industrymargins 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 its establishment, but once it i s set up it is 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 an important attraction for the authorities and the industry operators. The fact that (a) many o f the industryparticipants 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 95The World Bank is currently undertaking a study on the feasibility o fjoint petroleumprocurement within the sub- region. 96Postings are based on quotations from Petrotrin and Shell (which does not supply the sub-region). This system dates back to the 1950s and 60s when most o f the world trade was within major oil companies' integrated systems and SPOT market was less than 10percent o f transactions. The postings are unilaterally prepared by each individual (major) company. They are not prices generated in an open, competitive market and are often used by majors for inter-affiliate transfer pricing. 97For gasoline only. Diesel has a CET o f 10 percent and L P G and kerosene 0 percent. 104 needed by each authority in order to properly administer the system, provides enormous scope for collaboration across the sub-region. (iv) Maritime 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 incontainerization, improvements in port logistics technology, and evolution o f the governance and public and private management structures for the port industry. 6. 88 The main issue inmaritime 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 firms have reported that it i s not always reliable. Onthe export side, one result is that it 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, firms 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 on the firm survey report keeping stocks of more than one month and 10 percent o f them report having inventory periods that last as long as half a year. Such substantial inventory not only ties down the firms working capital resources, but also incurs additional costs in terms of storage and safekeeping. As we shall see below with intra-regional air transport, there is a need for additional analysis of the intra-regionaltransport 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 on the public service port model in which the port authority owns, maintains and operates all assets. Ina 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 inproductivity. Inat least one case, described inBox 6.5, this resulted inthe port resuming control o f cargo handling inorder to resolve the situation. BOX 6.5: DOMINICA'SEXPERIENCEWITH PORTCARGO HANDLINGOPERATIONS The Dominica Port Authority (DPA) had argo handling charges in the OECS owing to an outdated labor contract with the cargo handlers ' 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 situation), it accepted the co sequently, the DPA attempted to renegotiate wi . As an interim measure, theport 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 one- way fieight traffic and fac thin the OECS. After overtuming two injunctions by the union, the Government ha place new work arrangements at the Dominica Port Authority that have reduced stevedoring and rges by 25percent and chargesfor handling break-bulk cargo by 30 percent. In addition, the Po tiated reductions in, and eliminations oJ; surcharges by various shipping lines which the antiquated work arrangements. For example, the Caribbean Ship Owners A ed a surcharge of EC$190per 20-foot container. 105 6. 90 The 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 ifthe ships that dock there are to be accepted inother 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 will be crucial for all the ports inthe OECS to rapidly achieve and maintain the necessary security certifications inunison, so as to preservethe supply chain along the arc,hipelago. This suggests that the OECS should embark on ajoint effort to address this issue. There are currently some proposals for the establishment o f a sub-regional regulatory authority which would handle regulation, oversight, training and capacity buildingin security and other areas, which should be seriously considered. tourism industry - cruise and yachting sub- sector^.^^ 6. 91 The two remaining areas of maritime transport are important segments of the OECS The OECS countries have invested a significant amount o f public resources on 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 In light of the developments in the port sector worldwide with various models of private participation, the OECS might well explore the possibility of extending these models to its 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 regardingfinancing o f port infrastructure. However, financing alone, while it 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 inparticular because of limitations on the current airport capacity -- neither Dominica nor St. Vincent and the Grenadines can accommodate medium sizedjets 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 OECS is 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-ownedby most of the OECS governments and the Government o f Trinidad and Tobago. It has undergone several financial restructurings but i s still strugglingfor viability (see Box 6.7 below), BWIA, which provides service between the OECS and its various hubs in the Caribbean and links to its 98UNECLAC (2004b). 106 international destinations, i s owned primarily by the Government o f Trinidad and Tobago and also faces financial problems. More recently, the OECS has been served by Air Jamaica, inwhich the Government of Jamaica has recently re-acquired a significant stake after an unsuccessfulprivatizationeffort. 6. 95 The main objective of government policy on air transport is 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, like BWIA and LIAT, i s usually intended to serve two purposes: to ensure a minimumlevel 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 OECS countries when securing inter-regional airlift capacity may 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 from overseas locations in which they anticipate growing demand or which appear to be underserved. These incentives have been offered both on 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 airline inthe form o f a lump sum payment for joint marketing o f the route and destination; (ii) the more recent seat or load guarantee for a minimumcertain revenue per flight to the airline or charter company; (iii) direct lumpsumpayments totheairlinesimplyformaintainingaparticularroute. Experience and 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 to clearly specify the transfer pricing mechanism when airlines are providing multiple segments o f a trip terminating inthe country. 6. 97 In general, these incentives are negotiated bilaterally between a single country and a pre- identified airline which has already demonstrated interest inthe 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 on key routes may help to minimize the subsidies being provided to airlines. Periodic renewal o f these contracts may help to mitigate the risks from cyclical financial instability within the international airline sector, such as i s now 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 OECS countries appear to be reluctant to enter into an Open Skies agreement with US or European partners (see Box 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, would condemn the sub-region to a perpetual dependence on 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 no different. Box6.6: OPENSKIES AGREEMENTS International air service among states a a1 Air Services Transit Agreement and by complementary bilateral Air Services Agr the airlines of one state tofly (and carry passengers and cargo) into and beyond and capacity offlights, as well as other 99FAA category 1 status. 107 operational issues are normally covered in t five defined 'Ifreedoms of the air": The 1'' freedom relates The2"dfieedom relates The 3rdfreedom relates to carriers The 4"freedom relates to carriersfiom StateA picking uppassengersfrom State B. The jthfreedom relates to carriersfrom StateA picking uppassengers in StateB destinedfor State C. or setting downpassengers 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 3rdand 4Ihj?eedom rights have been limited, jthfreedom rights a degree of monopoly or duopo However, since 1992, the been reached to date, includ and Aruba in the Caribbean. These agreements each other's territory. Th unrestricted trafic rights, i 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 thesepolicies or regulations. 6. 99 On the intra-regionalmarket, 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 Box 6.7). 6. 100 The current situation is 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 on sub- regional aviation competition policy, inorder to resolve the LIAT situation and encourage the emergence of a reliable and stable market situation. BOX 6.7: A BRIEFHISTORYOF 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 years LIAT has received th from the Caribbean governments, further diluting private sha e. Yet, the airline still faces deep 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 inwasted public resources and increased indebtedness. 108 6. 102 Unlike with ports, the existence of the OECS 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 on 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 from the budget, whereas inothers they retainthe funds and are runas statutory corporations. 6. 103 In most OECS countries, taxi cartels have negatively impacted the competitiveness of the tourism industry by negotiating excessively high rates and competition-reducing regulations from the governments. Table 6.8 presents a comparison o f taxi fares and market arrangements inthe Eastern Caribbean. While most taxi systems worldwide involve some regulation such as licensing fees that limit entry and ensure quality of service and financial viability o f the operators, it i s common inthe OECS to find a host o f additional restrictions that turnthe industry into a set o f overlapping monopolies designed to extract the maximum rents from visitors. For example, taxi associations establish arrangements with individual hotels which 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. Little public information i s provided to visitors on rates to various destinations and meters are not commonly used. Insome 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 on 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 SELECTED CARIBBEANMARKETS IN Market entrants Taxi Association Fares regulated by regulated by regulate locations for $/Mile government? government? pick up and drop off? Antigua and Barbuda 1.51 Yes Yes Yes Grenada 3.OO Yes no Yes St. Lucia 2.40 Yes no Yes U S Virgin Islands 1.11 yes Yes No Source: Staff interviews with taxi associations. 6. 104 There is a general need to strengthen regulatory oversight of key utility, energy and transport sectors in the OECS - 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 by 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. Inthe case where private participation may not be feasible due to the small size of the systems, regional monitoring and benchmarking of costs, quality, reliability and efficiency o f operations can help local authorities and the general public better hold public (and private) entities accountable. Regional oversight may also help to dilute the political pressures to subsidize or cross-subsidize the electorate, which inevitably transfers national resources away from investment and productionto consumption. Box 6.8 describes briefly how even limited cooperation inCentral America on the petroleum sector has helped to achieve more efficient pricing and taxation in that region. 109 BOX 6.8: CENTRAL AMERICAN REGIONAL COOPERATIONINTHE PETROLEUMSECTOR pricing and taxation as well as 6. 106 Finally, intransport 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 of exporters and tourism operators. Inaddition, regional cooperation in port security issues, joint negotiations with inter-regional airline carriers and intra-regional airline competition policy are three other areas inwhich the sub-region could benefit substantially. 110 CHAPTER 7. OPPORTUNITIES FOREXPANDINGEXPORTS 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 GDP (excluding the government sector) increased from 53 percent inthe 1980s to 64 percent during2000-2003 (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 will be critical for future growth. Given relatively high wages, it is unlikely that the OECS can be competitive in labor- intensive manufacturing or 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 inniche 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 its geographical location, its Englishspeaking population, its alluring natural beauty, and rich 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 firms in the sub-region. As the case studies demonstrate, success in moving to higher-end services will require raising skill 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 be noted that this 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 is likelyto remaina 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 of market share within the Caribbean and worldwide has been lagging. The major reasons are declining cost competitiveness inkey market segments against new destinations inthe Caribbean and beyond, and slow response to the changing nature o f the tourism business worldwide. However, the strong growth projected inglobal tourism and the emergence o f new market segments inwhich the OECS has potential to compete have created the possibility for the sub-region to reinvigorate tourism and, further, to make it the centerpiece of a cluster o f new service exports. Inorder to realize this potential, the sub-region will need to update its strategy for managing and marketing the sector, focus public interventions and expenditures more closely on critical constraints such as the skills 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, all o f the OECS countries hope to 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 freceipts (see Table 7.1). looWTTC (2004) data on employment measure boththe direct and indirect impacts oftourism on the economy. 111 TABLE7.1: TOURISMSEGMENTS, 2000 Arrivals Receipts Spending per arrival ('000s) share (US$millions) share (US$) Stayover 852 36% 861 94% 1,011 Cruise 1,544 64% 52 6% 34 Source: CTO (2003). 7.5 Comparatively, the OECS 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 fell from 14.6 percent to 10.5 percent, and from 0.24 percent of world tourism to 0.17 percent between 1990 and 2002. Spending per arrival, although higher inlevel 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 DominicanRepublic and Cuba over the same period. TABLE 7.2: INTERNATIONALTOURISTARRIVALS BY REGION OFDESTINATION 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 DominicanRepublic 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 is accounted almost entirely by lagging performance in stay over arrivals. Growthinstay over arrivals fell from an average 8 percent per year during 1985- 94, to 0.1 percent in 1995-2003. Meanwhile the cruise sector has seen stronger, but also declining growth inarrivals, from 15 percent in 1985-94to 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 of tourist expenditures, and Antigua and Barbuda are the major players in the OECS group. While the cruise segment remains a minor player in terms of receipts accounting for only a 6 percent share of tourism earnings, the yachting sector i s strengthening as a key segment because of the higher per capita spending of these visitors. Like yachting, other new and emerging segments are not yet being measured systematically. 7.7 More recently, tourism in the sub-region has rebounded from the effects of the terrorist attacks in the US in 2001. Arrivals grew by 7.6 percent between 2002 and 2003, compared with an average decline of 2.3 percent per year in 2001 and 2002. This performance surpassed that of world tourism which continued to contract in 2003 on account of SARS and the war in Iraq, and of the Caribbean which grew by 6.5 percent in2003. 7.8 The loss of market share in both the Caribbean and world markets during 1990-2002 can be attributed to a loss of tourism-related price competitiveness in the principal sun, sea and sand ~ lo' The yachting sub-sector is not yet being systematically measured. 112 product offering. Untilrecently, the OECS tourism product comprised a dominant beachresort 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 interms of 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 CancdCozumel region in Mexico and more recently Cuba - were able to capture market share from both the OECS and broader CARICOM destinations. Inaddition, with the decline intransportation 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 life cycle" (WTO 2004). FIGURE7.1: INDICES OFPRICECOMPETITIVENESS INTOURISM 80 70 I " 60 60 -~ 50 50 -~ 40 40 -. -. 30 30 -~ 20 20 10 10 - 0 . 0 Note: These indices are based on 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 is 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 its physical and cultural assets, the OECS i s in a position to capture a growing market share of these segments. Indeed, the sub-region has already demonstrated its ability to 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. Kitts 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 of 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. InDominica, St. Kitts 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 inrecent 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 andadventure. 7.11 These emerging market niches have the potential to deepen the impact o f tourism on 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. Inthe 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 this 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 ifitistoensurecompetitiveness. 7.12 This interest of visitors inexperiencingmore of the destinationas a whole has deepenedthe public goodfactor in the tourism productionfunction, and presents challengesto 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. 7.13 Inorder for the OECS to take advantage o f the emerging market segments and to transform its 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 environmentalmanagement; 0 raise the capacity o f the industryto deliver quality services; 0 reform investment promotion strategies; 0 promote backward linkages intourism; 0 improve allocation o fpublic expenditures on tourism; and lo'Based on CTO, 2002-2003 data. This may have changed for St. Vincent and the Grenadines recently with the opening o f the Raffles Resort o n Canouan Island inthe Grenadines, 114 0 address trade-related constraints to tourism. 7.14 Destination management and marketing. The destination model requires a moderate and consistent level of 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 on 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 to 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 on addedurgency, 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 is key for successful destination management. In order to address the above concerns, the government will 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 on 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 on visitor needs at the expense o f the general public or the poor, and so a public education campaign may be required to explain the destination model and its beneficial spilloversto 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 will 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 its attention on the needs o f key investors, rather than the sector as a whole. This type o f coordination is 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 industryrepresentatives 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 to 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 helmas the public sector, will help to improve coordination. Inaddition, there i s a needto 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 on the development o f lo3 mainchallenge for thepublic sector isofteninchoosingbetweenwhenandhowto motivate andwhento The stipulate actions on the part of 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 marketingmodel inthe Eastern Caribbean relies heavily on 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 to 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 internationaltravel 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 will 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 inthe OECS, the industrywill continue to depend heavily on 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 from 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 to embark on a sub-regional effort to monitor critical eco-systems in collaboration with ongoing initiatives in the wider Caribbean. 7.22 Improvingproduct 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 on less price elastic and higher price portions o f the demand curve, as a way to offset high costs. However, without real improvements in quality o f service to justify the higher spending by visitors, this strategy will 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 on request [and] services such as porterage, 24-hour room service, laundry and dry-cleaning will be available."'04 Moving to the destination model will require an increase in the range o f skills required by the sector. Given the shortage o f skilled labor inthe OECS (see Chapter 5) this i s an important constraint that has to be addressed. Hotels inLondon (2005). 116 7.23 Tourism sector's human resource development is 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 of much of the applied skills training remains particularly dependent on donor projects or on internal training by the larger hotels. One hotel in St. Lucia suggested that it has probably trained all o f the massage therapists inthe islandthrough its 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 destinationand 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 on regional programs such as the OAS Small Tourism Enterprise Program (see Box 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 an important incentive for the private sector to improve quality. Ina recent inspection o f 211 small hotel properties inthe Caribbean conducted for the STEP program (see Box 7.1), the majority o f which were inthe 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 of the hoteliers were not aware o f the shortfalls intheir property because o f a lack o f awareness of these standards. 7.26 Worldwide, there has been an 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 this 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 in2004 for a recent World Bank report on the environmental sustainability inOECS tourism sector,lo5 just under 20 percent o f the respondents reported participating in voluntary environmental certification schemes. However, another 43 percent saw no 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 inpublicly- 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 inbusiness 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 to communicate and accept reservations by phone, fax or email and lo5 World Bank (2005a). I O 6Green Globe 21 i s a worldwide benchmarking and certification program for sustainable tourism. It i s based on Agenda 21 and principles for Sustainable Development endorsed by 182 governments at the United Nations Rio de Janeiro Earth Summitin 1992. 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 Box 7.1) created such a standard for assessing the capacity needs of the small hotel sector, and during its baseline survey found that two-thirds o f all small hotels in the Caribbeanwere not "market ready". Box7.1: THESMALL TOURISMENTERPRISESPROGRAM(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, 7.28 Reform investment promotion strategies. The OECS countries also need to reform their investment promotion strategy intourism OECS governments have long relied almost exclusively on the use o f fiscal incentives (and directed credit) to promote both foreign and domestic investment in the tourism industry. As noted above in Chapter 4 on the investment incentives, there i s no real economic rationale - based on 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. Kitts and Nevis the duration o f the tax holiday depends on 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 on 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 to 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 constructionmaterials, 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 inthe same market. Inone fairly egregious case, two 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 inthat country. Inthe end, the incumbent was unable to compete due to higher costs, and went out of business. 118 7.30 It should be noted that even though there is intense incentives-based competition for investors across the sub-region, a recent World Bank report on sustainable development in to~rism'~'found that there is 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 on the state o f the environment, however, may provide an excuse for decision makers to avoid the issue, particularly if the prevalent belief i s that rigorous environmental mitigation requirements may scare off 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 The 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 on administering fiscal incentives, tourism authorities have not paid sufficient attention to strengthening the broader environment inwhich investors operate. Inresponse, 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 inwhich hotels organize their own transportation from the airport, eliminate the need for their guest to frequent outside restaurants and bars, provide competing recreational activity on site, and arrange their own 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 be placed at riskby external forces that are not controlled by the investor. Ingeneral, 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 inwhich the investor also hopes to source clients. 7.33 Not 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. For example, a recent group o f investors on tour in Dominica needed precise and regular information from 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 Ministryo 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 on Tourism, and by the OECS Secretariat to coordinate efforts to promote the yachting sector mark important developments in this regard, and should be enhanced. 7.35 Promote backward linkages. The destination model also offers a new way to promote backward linkages from the tourism sector to the local economy. Visitors and governments alike have lamented the limited backward linkages from the tourism sector to the domestic economy all across the OECS. Inpart, this has stemmed from the predominance o f enclave type resort hotels attracted by the earlier investment promotion strategies (see para. 7.31). Inan attempt to encourage some linkages, most OECS countries imposed high duties on beverage imports, inparticular beer, inorder to boost sales from 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, reducingtheir internationalcompetitiveness. I O 7World 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. It 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. 7.37 Improve allocation of public expenditures on tourism. In 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, guarantees and investor-specific infrastructure raise the return to a single private operator, as opposed to spending on 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 million in Dominica to under US$300 million inAntigua, the budgets for management of the tourism sector in the OECS, and in the Caribbean, are quite small, at 1.7percent and 2.1percent of visitor spending respectively (see Table 7.3). Interms 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 reductionof fiscal incentivesshould be targeted to strengtheningthe 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 EXPENDITUREONTOURISM Tourism authority budget as a percentageof visitor Public investmentclassified under Tourism a expenditures as share of total capital expenditure (2001) (Avg 1995-2001) Antigua and Barbuda 0.92 Dominica 1.67 2.6 Grenada 2.21 3.5 St. Kitts and Nevisb 4.92 3.1 St. Lucia 1.94 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 investmentclassified under Transport and Communication or Infrastructure that would include re/construction of cruise ship ports, access roads to attractions, etc, and in some cases includes non-capital spending on donor-financed tourism projects. b. Includescapital spendingon culture and environment. c. Does not include Jamaica. Sources: CaribbeanTourism 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 of the tourism authorities in the sub-region are understaffed, and in some cases with non-establishedor contractpositions 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 restrictions to intra-regional travel which represent a growing share o f OECS arrivals, inthe form o f taxes and visas, which could be facilitated by the introductiono f a CARICOM passport; 0 Mode 2 restrictions on "consumption abroad" inthe form o f various types o ftravel taxes imposed by source markets when their residents travel overseas including to tourist destinations; 0 prohibitively low duty free exemptions for EU, US, and Canadian residents returning from CARICOM countries which encourage both cruise and stay over tourists to make purchases inthe 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 0 barriers to mode 4 movement o f tourism professionals and students hamper the Caribbean's marketing efforts and limit educational opportunities for its tourism students. B. Offshore education 7.40 There is an 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 on 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 decisionto increase or decrease support to medical educationwithin its 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 to 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-projected 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 inthe US.112 TABLE7.4: STATISTICSONTHE usMEDICAL PROFESSION 1970 1980 1990 2000 Active physicians to total physicians 83% 80% 66% 77% Women physicians as % o f total physicians 8% 12% 17% 24% Physicians over 65 as % o f total physicians 12% 14% 15% 18% International medical graduates as % of total physicians 17 21 21 24 Source: Swedish Development Advisers (2004). IO9This section is basedentirely on abackgroundpaper by SwedishDevelopment Advisors (2004). 'loSwedish Development Advisors (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. 121 7.43 In response to the growing demand for physicians, the number of residency positions at US hospitals has grown to around 20,000 positions per year, but in 2003 only 65 percent o f these positions were filled by US 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 by U S medical graduates. In order to fill the gap, US 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 from Federal, state and local governments (around US$17.1 billionper year,114or on average US$254,000 per student) this would imply an increase in government support by US$1.9 billion per year. Moreover since 1990, only one new medical school has been opened in the U S and first 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 still be demand for offshore medical education in the medium-term. 7.45 On the other side, based on 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 inthe next few years, as well 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. Of course, in the longer term, prospects for the sector will depend on how the U S market responds to the shortages inmedical 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 from the Caribbean offshore medical schools. Currently, there are an estimated 11,000 offshore students enrolled in these schools, half o f which attend schools in the OECS. Indeed, the two largest medical schools serving the US market are inDominica and Grenada. FIGURE7.2: INTERNATIONALMEDICAL GRADUATESTHE IN us,1984-2004 4,000 1 3,500 International Medical Graduates intothe US 1984-2004 4 3,000 9 2,500 * rA "0 2,000 0 b iE 1,500 1,000 500 Source: SwedishDevelopment Advisors (2004). `13SwedishDevelopment Advisors (2004). `14Ibid. 122 7.47 Moreover, there has been an increase in investment in this area in recent years. Of the 23 primarily'" offshore medical and veterinary schools inthe Caribbean, four were,establishedbefore 1990, seven between 1990 and 2000, and twelve inthe 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 two stages in the training o f physicians for the US 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 U S Medical Licensing USMLE Step 2, USMLEStep 3 M.D.program Examination (USMLE) MD degree and Step 1 National Resident Matching Program 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 (21 percent), endowments and charities (16 percent), with very little from tuition and fees (3 percent). 7.50 It is significantly less expensive and easier to establish an 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, which in tum may be reviewed by the U S National Committee o f Foreign Medical Education and Accreditation (NCFMEA) but only for eligibility infederal student loanprograms.II6 7.51 Because the schools concentrate on 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 inresearch, and many are on short-term contracts. The teaching staff i s a mix o f older experienced MDs or PhDs who have practiced or taught medicine in the US, or younger physicians who want to live in the Caribbean for a short period. None o f the schools interviewedindicated any difficulties inrecruiting 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 US medical schools. Rough estimates based on survey information o f the profit marginfor a small school o f 100 students inthe Caribbean are on the order o f 28 percent before taxes and financial charges. 7.52 As such, the offshore schools can compete with U S schools by 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. Most have shortened the '15The Caribbean has 37 medical schools registered with the WHO, but those inTrinidad and Tobago (l), Jamaica (1) and the Dominica Republic (9), and one of the schools in Guyana, cater primarily to domestic or regional students. 'I6In the Caribbean, the Cayman Islands, Dominica, the Dominican Republic, Grenada, Monserrat, Saba, St. Lucia and St. Maarten have been accepted by the NCFMEA as having appropriate accreditation standards for this purpose. 123 instruction period for the basic science curriculum by runningtrimester, instead o f semester, systems with no summer break. 7.53 Inorder toattractstudents,theschoolspreparestudents specificallyfortheUSMedicalLicensing 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 USMLE pass rates for a subset o f the schools surveyed, including the two largest, are as follows: TABLE7.5: OFFSHOREMEDICAL SCHOOL USMLEPASSRATES Number of schools Passrate 90% or above 3 Passrate above 80% 2 Passrate below 80% 1 Information not provided 3 Total 9 7.54 Inaddition, the New York and California state medicalboards, which oversee a large number of residency positions, do accredit foreign institutions - the two 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. Researchprogram Researchprogram not required Financially independentboard Private companyboards 130weeks of instruction Generally, 60 weeks of Basic Science Evaluation systeminplace instruction in situ plus 80-100 weeks of clinical rotations inthe USiCanada for residency Many rely only on USMLE results for programs evaluation aid programs and debt Few have placement systems but most counselling help to organize clinical rotations in Provision of health services & insurance U~Khnada to students Some schools are eligible for U S Federal loanprograms Some have health clinics, most do not provide health insurance Studentpop Avg age: 24 years Avg age: 27-30 years GPA: minimum3.6 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. More recently, however, institutional investors have gotten involved, with the purchase o f Ross University, first by venture capitalists and then by DeVry Inc., one o f the largest publicly-held higher education companies inNorthAmerica. 7.56 In 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. Inall 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 on imports of intermediate goods. Instead, most countries levy an annual per student tax or fixed annual fees on 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 harmonizethe tax treatment across institutions. 7.57 Estimates o f annual spending by students range from US$6,500 to US$21,000 for the countries surveyed. The surveyed schools employed some 710 local staff, paying higher than average wages inthe domestic market. The ratio of local non-medical staff to 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 to 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 is substantially large. First, the schools have an impact on local health care institutions to which they provide a range o f support interms 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. New entrants are beginning to differentiate their instructional approaches - one school has started a distance learning program, while another i s focusing on a holistic approach to training a "good" doctor with links to similar-minded clinical and residency programs in the US. 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 low 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 to difhse negative attention from U S associations that may lobby for expansion of domestic education in response to challenges on 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 well 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 its 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 on average at 11 percent per year since 1984. The emergence o f an Englishtraining cluster is a notable development inthis regard. C. ICT clusters 7.63 An important distinction to be made is between ICT as an output sector and ICT as a technology that enables the production of other goods and services in the economy. The former focuses on 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 ICT technologies throughout the economy and calls for attention to the development o f appropriate infrastructure, expansion .of ICT skills 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 is being, over-relied upon to be a major source of growth in the coming future. Most of 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 low wage-centric clusters such as call centers, and the failure to link foreign investment to local skills and generate spillovers. This section focuses onthe experiences to date with trying to develop I C T and ICT-related services as an output sector inthe 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 is covered in Section A and telecom infrastructure i s covered inSectionC. (i) Call centers and offshore business proce~ses"~ 7.65 The outsourcing of business processesto the Caribbean began as early as the 1980swhen U S companies started looking for low cost markets nearby. The Caribbean did manage to become a hub for a near shore data processing industrycoming out o f the US. Notably American Airlines established its data processing services in Barbados (see Box 7.2). However, when the U S companies began to face lower cost pressures, business fled to low wage countries like India and the Philippines. A t the same time, the market beganto 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 to keep up with skills and infrastructure requirements and was unable to compete for these new lines o f business. 'I7 This section is 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 assistedby an expert secretariat housed at the World Bank. 126 BOX 7.2: AMERICANAIRLINES' DATA PROCESSINGOPERATIONINBARBADOS In 1981, American Airlines ass subsidiary devoted to data processing services ent, customer queries and upgrades). I t decided to invest in Bar training, the work ethic, the stable environment and of the proximity to in 1998, the company, known as Caribbean Data Sew 1that it started servicing other big UScompan the Dominican Republic and Jamaica. By end of However, Caribbean take its services to the next level of complexity. As dataprocessing began to rely more on the use of the internet and online transactions, telecommunications costs in Barbados becameprohibitivefor this type of business. At the same time, the client companies were alsofacing 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 services in some core competencies, such as airlines, healt tourism customer service, in part because of the 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 injoint 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 had 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 to sell products and services and receive commissions on sales closed. Typically, a call center will purchase call lists i s paid by a credit card company based on how 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 on telemarketing and low-end customer service as a means to reduce widespread unemployment among the less skilled workers. This business generally competes on low labor and low connectivity costs. Because o f the relatively lower wages and the commission-based system, workers inthe OECS attracted to the call center business saw it 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 on 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 Box 7.3) is illustrative on a number o f these points. Box7.3: CALLCENTERSANTIGUA,LIMITED Call Centers A The hope was that skill 127 At these wage levels, the call center became the ere was low employee morale e a higher level of computer isbingjobs andpositions. The 7.68 Despite recent examples, there are viable opportunities in the call center business, if the OECS 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 on U S firms was to lower costs, quality o f customer service i s fast becoming a key source o f differentiation inthe 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 on longer-term contracts (2 years plus) because the call center has to make greater commitment in training which, focuses not only on customer service skills, but also on 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 of 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 to 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 hightech connectivity, with the mentality o f "if we build it, they will come". However, successful parks, such as the ones in Taiwan, Indonesia, Malaysia and the Philippines, are establishedto 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 hlly develop to a stage where all o f its components are pushing towards a common objective to enable innovation and increase competitiveness through cooperation. Inthe 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 to expectations due to wavering political commitment and inconsistent management. As such, the decision to establish a cyber park needs to be a strategic one that is 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 this sector as an opportunity to compete ina 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 industryearly on, basedonthe comparative advantages o fhavinga populationwith solid communications skills and in the same time zone as its main U S market, which up until then was under-served. The development o f the industrywas undertaken in a very proactive manner. Even more importantly than the fiscal incentives provided to attract firms, 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 firms 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 inthe industryand attracted companies to Antigua and Barbuda despite higher licensing fees and inmany cases higher wages. Licensing fees range from US$50-80,000 and involve an in depth due-diligence process, compared with Costa Ricathat offers fees as low 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 firms 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 its rules to allow only state-owned players in the sector. In line with international regulations, companies are required to keep their servers on 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 to take jobs inthe gaming industryand there is low turnover, because aside from the pay, "it's much more fun to be ina 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 inthe past, but demonstrated quick resolve to correct them. The first was the introductiono f a 3 percent tax on gross earnings which caused massive exit and was later rescinded. This experience is similar to that o f the UK which imposed a similar 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. More recently, the U S imposed a restriction prohibiting credit card transactions for online betting which severely reduced revenues. Antigua and Barbuda challenged this restriction inthe WTO and in August 2004 won an important victory. Negotiations with the U S are underway to reach a solution. The collaboration between the Gaming Commission and the industry on 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. It i s also a good example o f how the rules-based trading system of the WTO can work to the benefit o f small states. ' (iii) Softwaredevelopment 7.75 The computer software industry is a fairly new and fragmented sector in the Caribbean. Some o f the first firms sprang up duringthe 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 Jamai~a."~However, this was not supported by a comprehensive strategy for the development o f the industry. The experience of one firminBarbados (see Box 7.4) illustrates that fiscal incentives are rarely sufficient ifthere are other underlying constraints related to the business environment facing the sector. BOX 7.4: HIGH TELECOM COSTS HINDER THE SOFTWAREDEVELOPMENT INDUSTRY PRTLtd was one of thefirst software development companies in the Caribbean. This UScompany set up operations in Barbados in 1996and employed close to 300 Indianprogrammers 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 housingfor 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 thefirm 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 to 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 inthe Dominican Republic had a local programmer create CRM and logistics back end system customized to its customer base for less than one tenth o f the price o f established o f f the shelf software. Inturn, the software developing process and upgrading can also help cultivate domestic talent that flows into a local computer software industry servingboththe private andpublic. 7.77 The OSS industry in the Caribbean is still 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 no one really knows what the other players are doing in the region. However, a few o f these players are trying to foster collaborationthroughout the industryto create a forum to share innovative ways inwhich OSS has been used, and to reduce the amount o f duplication and replication across the region. Digisolv, Inc inSt. Lucia i s one such firm (see Box 7.5). BOX 7.5: PROMOTING OPEN SOURCESOFTWARE DEVELOPMENT IN ST. LUCIA Digisolv, Inc is a software company in St. Lucia that provides networking and network-oriented solutions toprivate companies, governments and NGOs. The company started out in hardware sales but quickly moved to offering sophisticated ICT 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 industrythan "feasibility studies" prepared by donors and government officials. As such, ' I 9 Cleland and Gomez (2003). I2O Open Source Software is software for which the underlying programming code is 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 of Open Source Software differ in the licensing terms under which altered copies of the source code may be redistributed. 12' InfoDev (2005). Data on the number of firms operating in this sector does not 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 to IT training to more sophisticated business segments. 130 mechanisms for identifying and supporting similarly innovative and proactive entrepreneurs should be an important part of the government's private sector development strategy. D. Health and wellness services 7.79 Some emerging trends in the OECS point to potential for joining the growing cross-border delivery of health and wellness services worldwide. These trends include: (i) increasing number o f an 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 Box 7.6); (ii) a steady stream o f medical professional recruits to North America; (iii) offshore medical the education sector; and (iv) the proposed private development o f a regional nursingtraining school in St. Kitts andNevis. BOX 7.6: WORLDCLASSWELLNESS FACILITIES INTHE OECS 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 Le Sport the number one destination spa in the world and one of the 100Best of The Best in Travel. The resort's main ofering, the Body Holiday, combines a beach vacation with thepersonalized 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 hasfacilities for families and those traveling alone. Le Sport targets the European market, primarily UK and Germany. It is owned and operated by a St. Lucianfamily 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 lizes a combination oj efective therapies to address add 29-day residential 12- UK). In terms of treatment and Betty Ford and Hazelden centers, but costs much less at about US$14,500for 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 thefact 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 will 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 inhealth services including Modes 1 and 2 may in fact grow at much higher rates. 7.81 The OECS has several characteristics which make it an appealing destination for visitors seeking offshore health and wellness services. These include its proximity to North 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 inhealth services can be grouped into three categories. The `first, a government-led approach, i s based on 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 this approach. Finally, Latin American and East Asian countries have both adopted national policies or strategies and also have expandedprivate sector growth inthis 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, will 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 inpublic health systems, it is likely that any growth inhealth and wellness service exports will evolve initially through the tourism sector and the wellness and spa business. 7.84 There are a number o f constraints and issues that would still need to be addressed with public 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 be 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 skills 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 injoint private sector ventures. There may be scope for offshore training facilities to provide staff for local markets. The experience of 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 inthe OECS, eventually offsetting some o f the cost competitiveness inthis sector. Greater flexibility on intra and inter-regional mobility o f healthprofessionals would help to mitigate some of this effect. 7.87 In the event medical tourism is 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 by 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, nursingbodies and the Joint Commission International. 7.88 Increasingthe 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 non- emergency 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 incase management across internationalborders may be lessening this problem. Inaddition, the OECS countries may want to ensure that this issue i s adequately addressed inthe FTAAnegotiations. 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 this 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 indevelopment o f viable business plans for expansion o f spdwellness services, and indevelopment ofpublic-privatepartnerships, including carefulmarket 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, North America, and Asia. The Caribbean mightbe informed by the experiences of other countries withhealthtourism, particularly from the Apollo Health Services inIndia which caters to bothnational 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, it 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 this effort, it may be useful to establish a health tourism desk at the national level to collect and evaluate data. E. Offshorefinancial 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 on 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 with 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 on 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. TABLE 7.7: OFFSHOREFINANCIALCENTERS Banks IBCs* Trusts Mutual Insurance Max % o f current revenues hnds companies collected during 1995-2000 Antigua and Barbuda 15 6,000 -- -- 6.6 (1999) Dominica 1 8,000 ---- -- -- 5.2 (1998) Grenada 44 3,400 11 -- -- 4.6 (2000) St. Kitts 1 13,800 -- -- -- 3.3 (2002) Nevis 1 17,000 -- -- St. Lucia 1 61 -- 2 ---- ... St. Vincent and the Grenadines 9 6,000 350 15 9 1.5 (2000) OECS 17 3.6 (2000) The Bahamas 200 117,520 n.a. 700 230 1.3 Cayman Is. 450 30,000 n.a. 2300 500 14.6 Br.VirginIs. 0 314,000 n.a 2000 360 54.6 * Internationalbusiness companies. Sources: Suss, Williams and Mendis (2002) and U S Department o f State (2004). Fees paid to government are captured in the balance o f payments accounts. In addition, there is an attempt to measure payments made to local service providers as well in the balance of payments. National accounts statistics only captures data on domestic investments o f offshore entities. 133 7.92 With the exception of Nevis, none of the OECS countries have succeeded in establishing a significant market presence in any of the offshore financial services market segments. Table 7.7 provides comparative data on 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 The 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 hrther growth inthe market is likely to come from increasing complexity o f the services provided to the holders o f offshore assets, rather than simply inthe 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 skills in terms o f services to be provided by local agents and ICT 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 runthe risk o f reputational events that could dampen future growth. 7.94 With the recent upward trend in international financial markets, there is some potential for a rebound in the offshore financial services sector on the volume side o f the business. However, without strengthening the types o f services offered inthe OECS, offshore financial services are likely to remain at the current low 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 OECS offshore financial sectors will require a major expansion of accounting, financial and IT-related skills as well as improvements in the telecom infrastructure for data transmission. 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Stewart, T., E. Roker, A. Quan, R. Hamilton, A. M. Grant. McH. Andrew. F. Lewis and A. Abraham. (2003). "An Empirical Examination of Competition Issues in Selected CARICOM Countries: Towards Policy Formulation," Processed. Suss, E., 0.Williams and C. Mendis (2002). "Caribbean Offshore Financial Centers: Past, Present, and Possibilities for the Future, IMFWorking Paper WP/02/88. Washington D.C. " Swedish Development Advisers (20042. "Offshore Education inthe OECS," Backgroundpaper prepared for the World Bank, Processed. Tax Reform and Administration Commission (2004). "New Approaches to Taxation and Tax Administration in the Eastern Caribbean Currency Union" Prepared for the Monetary Council of the Eastern Caribbean Central Bank. Basseterre, St. Kitts. Talon, P. and K. Kraemer. (1999). "Information Technology and Economic Development: Ireland's Coming of Age with Lessons for Developing Countries," Center for Research on Information Technology and Organizations, Universityof California at Irvine, Paper No. 136. Irvine, California. UNDP (2002). OECSHuman Development Report, New York. UN ECLAC (2003). "Special and Differential Treatment: Effects and Implications for Small Open Developing Economies." Report deliveredto ASSA Meetings on January 3-5,2003, Washington D.C. (2004a). "Issues, effects and implications of the Free Trade Area of the Americas (FTAA) agreement for CARICOM economies," No. LC/CAR/G.773. Port-of-Spain, Trinidad and Tobago. (2004b). "Yachting in the Eastern Caribbean: A Regional Overview," Publication No. LC/CAR/G.775, Port-of-Spain, Trinidad and Tobago. 140 UNESCO Institute for Statistics (2001). "Good Neighbours: Caribbean Students at the Tertiary Level of Education", UNESCO. Paris, France U S Department of State (2004). 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Stotsky and E. Ley (2002). "Tax incentives for business investment: a primer for policy makers indeveloping countries" World Development (U.K.);30(9): 1497-1516. 142 ANNEX1:GRENADA INVESTMENT CLIMATE SURVEY A survey o f 201 firms was conducted in Grenada between January - April 2004 in order to gather the firm-level data for A Diagnostic Review of the Investment Climate conducted by FIAS. The survey instrument shares much o f its structure and focus with other investment climate assessments carried out under the World 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 list o f firms that make contributions to the national insurance scheme (NIS) for their ~ 0 r k e r s . The~ sampled firms were chosen to ensure that they broadly reflect the l ~ Grenadian economic structure and focus on the areas where the Government actively encourages more investment, In addition, special attention was paid to large companies (those with 25 or more employees), firms in manufacturing and tourism and tourism-related sectors, as well as foreign owned establishments inorder to gain a deeper understanding o f their dynamics. Although most o f the sampled firms are located in St. George's town (98 firms) and St. George's parish (68 firms), other parishes are represented as well, including 12 firms in St. David's, 11 firms in St. Andrew's, 3 firms in St. John's parishes, and 5 firms in Carriacou. Some of the key features o f the sample are highlighted here, while a more detailed breakdown o f the participating firms by size and sector can be found inthe table below. Sector distribution. The sample includes 44 manufacturing firms and 56 tourism-related firms. The tourism sectors are broken down into hotels, including firms 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 to tourists (e.g. duty free shops). The classification o f enterprises by sector i s based on the recording o f primary activity. It should be noted that five o f the retail firms have manufacturingas secondary activity. Foreign companies. The sampled firms include 45 companies with 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 CARICOM countries (19 firms), followed by the U S A (12 firms) and the UK (7 firms). Age of establishments. Most of the firms (63 percent) have been inoperation for more than 10 years, and just under halfo fthese were establishedover 20 years ago. Women in business. Overall, very few firms (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 firms - women figure far more prominently indomestic firms than in foreign owned firms. 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 it 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 of sources were considered. The Company Registrar's Office provided a list, but not all companies on the list are actually operating and that there is 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 list o f companies with information on employment, sector and location, facilitating the breakdown o f the sample frame to focus on specific target groups of companies. `25Including having women as the largest shareholders. 143 DISTRIBUTIONOFFIRMSINSAMPLE BY SIZE AND SECTOR Micro Small Medium Large Total Domestic Foreign <10 employees 10-24 25-74 75+ Total 71 55 43 32 201 156 45 Agriculture 2 2 0 1 5 5 0 Food processing 7 7 6 2 22 19 3 Garment & textile 2 3 1 0 6 6 0 Other manufacturing 6 4 4 2 16 15 1 Retail trade 9 3 7 3 22 17 5 Wholesale trade 4 2 3 2 11 8 3 Financial services 5 3 4 2 14 6 8 Information & Comm. 2 3 0 3 8 5 3 Construction 3 5 1 5 14 10 4 Hotels and restaurants 3 3 8 5 19 12 7 Other tourism related 21 10 4 2 37 29 8 Other 7 10 5 5 27 24 3 Manufacturing 15 14 11 4 44 40 4 Tourism 24 13 12 7 56 41 15 Foreign-owned 15 7 8 15 45 144 ANNEX2: CARIBBEAN FOREIGNINVESTOR PERCEPTIONSURVEY A Foreign Investor Perception Survey o f 159 multinational firms 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 on key firmcharacteristics, the firm's evaluation o f 42 factors in 8 categories that constitute a country's investment climate, the firm'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 firms 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 inthe Caribbean. Sample Selection. The sample was selected from an extensive list o f firms obtained from the investment promotion agencies and chambers o f commerce inthe Caribbean. Of 1,400 actual and potential investors compiled from these sources, 650 companies were selected as interview candidates. These firms were selected because they have international investments, represent a wide variety o f sectors, and provide a fair representationo f the different countries inthe Caribbean. Intotal, 201 companieswere interviewed. Ofthese, 20 firms haveheadquarters intheCaribbeanandare potential investors in another country inthe region. However, the data collected from these investors was inadequate for an in-depth analysis. Inaddition, 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 inthe report is based on the informationprovided by 159 firms. While one o f the aims was to include firms at different stages o f investment, information on past and prospective investments was difficult to obtain as very few enterprises are willing to discuss their future projects, or past failed efforts. Thus, with the exception of a few cases, information collected reflects the views o f the enterprises that have invested inat least one country inthe Caribbean. Sources of investment. Firms with headquarters inNorthAmerica 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 firms originate from Europe and one from Japan. Over a third o f the firms have a global workforce o f only less than 100 people, but 23 percent o f the firms have more than 10,000 workers globally. Size of investments.The majority o f the foreign firms 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 firms. Correspondingly, the realized investments are also limited insize, with more than a third o f the firms making investments o f less than US$1 million. Characteristics of the Caribbean subsidiaries. Most o f the companies (52 percent) are privately-held companies with limited liabilities. Publicly listed companies account for another 36 percent, while other forms o f legal status (such as partnership, cooperative, etc.) are only marginally represented. The majority o f the firms serve only the local market, although a significant share o f the foreign-owned firms (20 percent) export all their production. lZ6 ForeignInvestmentAdvisory Service(World Bank/IFC). 145 Table 1presents the distribution o f the firms by leading activities, as well as the average size o f the work force, and levels of investment. Firms intextile and garments industries, which have one o f the lowest capital intensities among all types o f companies, are large employers and foreign exchange earners due to their export-orientation. By contrast, firms in the ICT-enabled services bring in much more capital on average, but do not provide as much employment and are much more geared towards serving the domestic market. DISTRIBUTION OFFIRMSINSAMPLE BY SECTOR Number o f Average Average f m s in sample number o f investment employees (US$'OOO) Agriculture 5 49 255 Food processing 20 296 21,575 Textile & garments 10 682 3,472 Electric and electronics 12 325 85,950 Other Manufacturing 19 223 28,707 Tourism 10 249 29,536 Financial services 11 124 38,303 ICT-enabled services 13 91 97,011 Transport 5 40 1,830 Medical services 11 348 81,756 Professional Services 10 55 6,047 Construction 4 208 525 Energy 12 174 669,363 RetaiUwholesale Services 17 135 5,133 FIRMS'RANKINGOFINVESTMENTCLIMATECOMPONENTS Percentage (YO)of respondents that considered either major or critical Rank Major Critical Both ` I Telecommunication 46.4 42.8 89.2 2 Power supply 43.5 42.5 86.0 3 PoliticaUregime stability 41.8 43.9 85.7 4 Favorable attitude in country towards FDI 48.8 34.1 82.9 5 Labor productivity 41.8 40.7 82.5 6 Shipping and ports 39.9 41.5 81.4 7 Exchange rate stability 44.4 35.7 80.1 8 Tax rates 45.7 33.5 79.3 9 Skilled labor cost 44.9 34.2 79.1 10 Clarity and fairness o f laws and 51.3 27.4 78.7 11 Availability o f skilled technicians 45.8 32.1 77.9 12 Labor relations 46.6 31.1 77.7 13 Water supply 43.0 34.2 77.2 14 Quality o f life 52.6 23.2 75.8 15 Health o f the workforce 48.1 27.6 75.7 16 Investment incentives 42.7 32.6 75.3 17 Local market size 42.6 31.6 74.2 18 Air transportation 38.3 34.7 73.1 19 Roads 39.2 33.0 72.2 20 Customs clearance procedures 39.0 33.1 72.1 21 Import tariff 39.9 31.5 71.3 22 Security and absence o f crime 41.6 28.9 70.6 146 23 Unskilled labor cost 48.1 21.6 69.8 24 Tax administration and auditing 43.0 26.3 69.4 25 Investment facilitation and services 44.3 24.7 69.0 26 Government efficiency 49.5 18.9 68.4 27 Labor market flexibility 47.6 20.3 67.9 28 Business registration and licensing 40.5 27.2 67.7 29 Judiciary and contract enforcement 43.1 21.3 64.4 30 Foreign exchange restrictions 41.8 22.3 64.1 31 Export incentives and EPZs 33.6 26.7 60.3 32 Local supply o f inputs 37.1 19.7 56.7 33 Access to local finance 36.9 19.6 56.4 34 Quantitative restrictions 32.5 22.1 54.5 35 Availability o funskilled labor 32.8 21.7 54.4 36 Anti-monopoly practices 36.3 16.4 52.6 37 Proximity to your other operations 31.4 17.1 48.6 38 Access to natural resources 29.5 17.5 47.0 39 Access to land 28.1 14.0 42.1 40 Government and venture capital financing 26.0 14.5 40.5 RANKING OF THEFIVECOUNTRIESFOREACH INVESTMENTCLIMATEASPECT Barbados Dominican Grenada Jamaica Trinidad Republic and Tobago Policy and legal environment 1 - Politicahegime stability 1 5 4 3 2 2 - Exchange rate stability 1 5 3 4 2 3 - Clarity and fairness o f laws and regulations 1 4 2 5 3 4 - Government efficiency 1 4 2 5 3 5 - Security and absence o f crime 3 2 1 4 5 6 - Judiciary and contract enforcement 1 5 4 3 2 7 - Anti-monopoly practices 1 3 4 2 5 FDIframework 8 Favorable attitude incountry towards FDI - 4 3 5 1 2 9 - Investment incentives 1 2 5 3 5 10 - Export incentives and EPZs 2 1 4 5 3 11 - Investment facilitation and services 2 3 5 1 4 12 - Access to local finance 1 2 3 5 4 13 - Government and venture capital financing 1 2 5 3 4 Market access 14 - Local market size 2 3 5 1 3 15 - Local supply of inputs 4 3 5 2 1 16 - Proximity to your other operations 4 1 3 2 5 Labor 17 - Availability o fprofessional workers 3 1 5 2 4 18 - Availability o f skilled technicians 2 1 5 3 3 19 - Availability o f unskilled labor 2 1 4 5 3 23 - Labor productivity 2 1 5 4 2 24 - Labor relations 2 1 5 3 4 25 - Labor market flexibility 2 1 5 3 4 26 - Health o f the workforce 4 1 3 2 5 Administrativeprocedures 27 - Business registration and licensing 5 3 4 1 2 147 Barbados Dominican Grenada Jamaica Trinidad Republic and Tobago 28 - Foreign exchange restrictions 2 2 5 4 1 29 - Access to land 4 2 1 5 3 30 - Access to natural resources 3 1 2 5 4 Taxationand Customs 3 1 - Tax rates 4 1 5 3 2 32 - Tax administration and auditing 3 2 5 1 3 34 - Quantitative restrictions 4 3 2 5 1 35 - Customs clearance procedures 2 3 5 4 1 Injiastructure 36 - Telecommunication 1 2 4 5 3 1 - Power supply 5 3 4 2 38 - Water supply 5 4 3 2 39 - Roads 1 2 3 4 40 - Air transportation 2 5 1 4 41 - Shipping and ports 2 4 1 3 42 - Quality o f life Other 3 5 2 4 1 SUMMARYOF IMPORTANCEININVESTMENTCLIMATE FACTORS Sector Most Important Factors Not So Important Factors Agriculture Favorable attitude incountry Access to local financing towards FDI Proximity to firm's other PoliticaYregime stability operations Labor productivity Availability o f unskilled labor Labor relations Shipping and ports Foodprocessing Exchange rate stability Access to land and natural Tax and investment incentives resources Shipping services and ports Proximity to firm's other PoliticaYregime stability operations Telecommunication facilities Anti-monopoly practices Garments and textile Import tariffs Access to natural resources PoliticaYregime stability Anti-monopoly practices Favorable attitude incountry Foreign exchange restrictions towards FDI Labor productivity Availability o f skilled technicians Electric and Labor productivity Local supply o f inputs electronics Telecommunication facilities Quantitative restrictions Power supply Access to land and natural Exchange rate stability resources Availability o f skilled technicians Other manufacturing Shipping services and ports Proximity to firm's other Power supply operations PoliticaYregime stability Government and venture capital Availability o f skilled technicians financing Labor productivity Anti-monopoly practices Tourism Air transportation Proximity to firm's other Availability o f skilled technicians operations Business registration and licensing Export incentives and EPZs Favorable attitude incountry Quantitative restrictions 148 Sector Most Important Factors Not So Important Factors towards FDI 0 Investment incentives Financial services 0 Telecommunication facilities Proximity to firm's other 0 Politicallregime stability operations 0 Investment incentives Access to land and natural 0 Power supply resources 0 Cost o f professional labor Availability o f unskilled labor ICT-enabled services Telecommunication facilities Access to land and natural 0 Power supply resources 0 Cost o f professional labor Availability o f unskilled labor 0 Labor productivity Cost o f unskilled labor 0 Local market size Transport 0 Export incentives and EPZs Import tariffs 0 Customs clearance procedures Access to natural resources 0 Air transportation Availability o f skilled technicians 0 Telecommunication facilities 0 Power supply Medical services 0 Telecommunication facilities Access to land and natural 0 Customs clearance procedures resources 0 Favorable attitude incountry Local supply o f inputs towards FDI Local financing options 0 Labor productivity 0 Shipping services and ports 0 Cost o f unskilled labor Professional services Availability o f unskilled labor Anti-monopoly practices 0 Labor relations Access to land 0 Cost o f skilled labor Government and venture capital 0 Favorable attitude incountry financing towards FDI Security and absence o f crime Construction Local market size and supply o f Quantitative restrictions inputs Export incentives and EPZs Availability o f skilled technicians Government and venture capital Import tariffs financing Quality o f roads Energy Access to natural resources Government and venture capital Cost o f professional labor financing, or other local financing Shipping services and ports options Power supply 0 Proximity to firm's other Judiciary and contract enforcemenIt operations 0 Availability o f unskilled labor Retail and wholesale Shipping services and ports 0 Access to land and natural trade 0 Air transportation resources 0 Telecommunication facilities Local supply o f inputs 0 Labor productivity Local financing options 0 Power sumlv 149 ANNEX3: LABOR RIGIDITYINDEX Sources Laws and Regulations Persons Interviewed Dominica Labor Force Survey, 1999 Leo J. BernardNichols, Industrial Relations Act: Chapter 89:Ol General Secretary, Dominica Protection of Employment Act: Chapter 89:02 Trade Union Labor Contracts Act: Chapter 89:04 Labor Standards Act: Chapter 89:05 Employment Safety Act: Chapter 90:08 Grenada Employment Act 1999, Act. 14 Sonia Alexis, Ministry of Labor Statutory Rules and Orders, No. 11, the Minimum Wages Order, 2002 St. Kitts and MinimumWage Code 625,2004. Clifford Thomas, Labor Nevis Protection of Employment Act, No 6, 1986. Department St. Lucia Draft Labor Code, 2004. St. Vincent Protection of Employment Act, 2003, F.Williams, Public Service and the Statutory Rules and Orders 2003 Nos. 12, 13, 14, 15, Union Grenadines 16, 17, 18. The Cost of Firing Legally mandated notice Severance pay for What is the legally Firing Costs = period for redundancy redundancy dismissal as mandated penalty for sum of weeks dismissal (inweeks) after number of weeks for which redundancy dismissal? twenty years of continuous full wages are payable after (weekly wages) employment? continuous employment of twenty years? Antigua and Barbuda 34 weeks Dominica 8 weeks 49 weeks 0 57 Grenada 8 weeks 20 weeks 0 28 St.Kitts and Nevis 10 weeks 52 weeks 0 62 St. Lucia 6 weeks 102 weeks 0 108 St. Vincent and the Grenadines 4 weeks 38 weeks 0 42 The Rigidity of Hours Index Can the Does work Are there Are there Days of annual leave Rigidity of workday week consist restrictions restrictions with pay in Hours Index extend to 12 of 5.5 days or on night work on "weekly manufacturing after 20 hours or more? N=l, ? N=O,Y=l holiday" years of continuous more? N=l, Y=O work? N=O, employment? I s this Y=O Y=l. leave 21 days or less? N=l, Y=O Dominica 0 0 N o 0 0 0 Grenada 0 0 N o 0 0 0 St. Kitts and Nevis 0 0 N o 0 0 0 St. Lucia 1 0 N o 0 0 20 St. Vincent and the Genadines 0 0 N o 0 0 0 150 The Difficulty of Hiring Index Ratio of min to Fixed-term contracts are only What is the maximum duration Difficulty of average wage (a) allowed for fixed-term tasks? of fixed-term contracts (in Hiring Index Y=l, N=O. months)? (b) Dominica 0.02 1 36 50 Grenada 0.04 0 No limit 0 St. Kitts and Nevis 0.10 0 N o limit 0 St. Lucia 0.00 1 24 67 St. Vincent and the Grenadines 0.02 0 No 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 is 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 ifthe ratio i s below 0.25. (b) A score of 1is assigned ifthe duration of term contracts is 36 months or less; 0.5 ifthe duration is between 36 and 60 months; and 0 ifterm 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 of FiringIndex I s The employer The employer The employer The employer The law There are There are Difficulty redundancy must notify a needs the needsthe must notifya mandates priority rules priority rules of Firing considered third party approvalof a approvalof a third party retraining or applyingto applyingto re- Index grounds for before third party third party to prior to a replacement dismissal or employment? dismissal? dismissing prior to a dismissone collective prior to lay-offs? one collective redundant dismissal? dismissal? redundant dismissal? worker? employee? Dominica Yes Yes Yes Yes Yes N o Yes No 60 Grenada Yes Yes Yes Yes Yes No Yes N o 60 St. Kitts and 20 Nevis Yes No Yes N o No No Yes N o St. Lucia Yes Yes Yes No No No Yes N o 30 St. Vincent Yes Yes Yes No N o No N o Yes 30 and the Grenadines 151 ANNEX 4: A N EXAMPLE DESTINATION-SPECIFIC"EXPORT OF READINESS" CRITERIA Tourism BritishCblurnbia Export Ready Criteria t" The follo~vi~tg criteria are used by Triuim Bntrsh Columbiawhen detesmruingif a supplier or DMO IS ready 80 work with Tousism BC LD offering "expoIt ready' prodilict to iutemanonal markets: Suppliers Must: * Be inbuciness at least oue year. wirh aproven track record for safe and profe5sioiialopemtion. * Demonsmate an a&quare budget and marketinsplan h a [ includes innmanonal IOU operators. I Undersltsmdthe roles played by receptive tour operators (F.Tr3.5). tour operator%tra:-el xvholesalers: andretail rrar-elagena. Tlus iuchidw anuudersauduq 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 inyour mal'lie~lllgand sales pian andimplementrl regular sales call proyam directed toward thew operatork. Be n d l ~to proride connacwd wholesale net ratesto recepttvetour opemtorr.. As a general g mideline, requuemenaare: 15% off the r e t dprice for day acnviues and transportation and ?cS-3D?b off*retad pricing for accomrJloda~ousfigher discountr are con"n for rolilllre producdou). Honour tlie cmmacted net ram. no price changesbefore the expiqr o f h e conrractedayeemat. I Provide beailed propamiafomaticn to tom opeeratoasandreceptive operators a i least one yew inadvance ~ S O M .1.e.May 1999 for the su"er:'fall ,000 season. Be preyxedto coiumuuicate and accepc reseT["ms by rekpholme. fax and:or e-mail. Prowle sanie- day coufimtiouo fbookiug amgeuaents. c Set up billing anaqemenis wita t5e operator. agexy or receptive tow operator. Aecep: client rouchen as c o n h a t i o n of palimmt for reservations. * De;er&e busmesspriorities interm of goup or FITbusiness. Ifyou planto pmue group business. consider ~ C C C S S by tom he-3. parkiqy'timarouud areag: ~vashoomr l i w s etc. Detenuineyour mx~miw youp size. Caw adeqnatemsmauce(muhim'$3 mllionliabihtyiusiumcefor a&;ennue product cj recommended). Discuss this with your receptive operator (sometimesthey can add sup esismg pohcies at nominalcczt). I h m d e mpyort ( h e OF reducedrates] for mtemationd media and travel trade fauntharizatioat o m . Inaddtion to the above, &e follo~lngshouldbe cousidered '-next step<' for considerahas business and niaaket presenceexpands. * Consider atrcndmg travel twde &oxn mvol7,iq utematronal b y m . eitlier uI i o d .herica or overseas. + E s p d;he sabc call psopamto luolfude overseas contacts a I!a5Cmada-basedreceptive operators. * Be preparedto pror.ide EQIU operazors and media wih 3 5 m slide. Cf) ROM or standard computer fomar m a p of the product or operation. for w e inbrochures, promotions and editorials. I Consider produc&r video footage o f product cr operadon for promotianal and r r a i n i q p ~ ~ ~ e ~ . I f o m t i o n onyour product. * Be preparedro adapt to uniqueness o fce Consider kelopment of R website offerh vmea-3markets. Flexibility may be requmdwith regard to last &ut@ bookiugswd chanzes. Consider hmg fronthe staff that speaks the laupage of tlre markets you are mTeFc3tedlu.piu"uiug. Source: http://www.designingnations.com/pdf_s/TBC%2OExport%2OReady%2OCriteria.pdf 152