Trade Liberalization in the
Janet Stotsky, Esther Suss, and Stephen Tokarick
During 1994-98, the economic performance of
the Caribbean region (Antigua and Barbuda, The Bahamas, Barbados, Belize,
Dominica, Grenada, Guyana, Jamaica, St. Kitts and Nevis, St. Lucia, St.
Vincent and the Grenadines, Suriname, and Trinidad and Tobago) was broadly
satisfactory—though characterized by wide variation among
countries—notwithstanding the international financial turmoil that
affected many developing economies in Latin America and Asia. Real GDP
grew about 21/2 percent a year during 1994-98, ranging from growth of more
than 7 percent a year for Suriname to a decline of about 1/2 of 1 percent
a year in Jamaica (Table 1). Inflation remained low in general, and the
balance of payments remained viable, with the external current account
deficits more than covered by inflows of direct investment and
concessional assistance. This performance reflected, to a large extent,
sound macroeconomic policies and structural reforms, most notably
privatization and efforts to enhance competitiveness in the services
sector (for example, in telecommunication services). In 1998, the region
had a total population of about 61/2 million and a combined GDP of about
$24 billion, resulting in an income per capita of about $3,700, compared
with about $3,900 for Latin America.
Traditional economic activities—such as agriculture and extraction of
natural resources—continue to underpin the Caribbean economies, although
in recent years there has been a shift into tourism and other services. By
virtue of their size, these economies are very open, with exports and
imports of goods and services both averaging more than 100 percent of GDP.
Their high degree of openness, coupled with relatively narrow production
and export bases, leaves many of the countries vulnerable to external
shocks. External shocks may, however, affect Caribbean countries
differently. For example, the recent rise in world oil prices has boosted
the export earnings of Trinidad and Tobago, an oil-exporting country, but
increased import costs for much of the rest of the region.
In recent years, many of these countries have seen their preferential
export arrangements diluted or threatened, and some have been faced with
the loss of export and other trade privileges for their main products
(including bananas, garments, and sugar). In addition, there has been a
reduction in concessional aid and external grants received by countries in
the Caribbean region.
Since the mid-1990s, the Caribbean governments have taken important steps
to increase the integration of their economies into the world economy in
order to increase productivity. These have largely taken the form of
regional trade integration, which is seen as a step toward establishing
even closer forms of monetary and economic cooperation. In this regard,
the Eastern Caribbean Currency Union and its associated Eastern Caribbean
Central Bank—which were created in 1983 and whose members include Anguilla,
Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis,
St. Lucia, and St. Vincent and the Grenadines—have been quite successful
in maintaining a stable exchange rate and low inflation. The global
integration movement started with the removal (or reduction) of trade and
payment restrictions in the 1980s. In this first phase, countries began to
dismantle import and export licensing arrangements and reduced foreign
exchange controls. Further trade liberalization measures were undertaken
in the 1990s. Recently, the Caribbean countries entered into an
arrangement with several Latin American countries to form the Association
of Caribbean States. The Caribbean countries have also signed various
protocols with larger markets, including the United States (the current
Caribbean Basin Initiative). In addition, they are aiming to establish a
single market and economy under the Caribbean Community (CARICOM) in the
next few years.
While it is difficult to gauge the impact of trade liberalization so far,
preliminary indications are that it has benefited the Caribbean countries
by expanding their exports of goods and services, which has boosted their
economic growth. The reduction in import tariffs, which has been an
integral part of the trade-liberalization strategy, appears to have
reduced tax revenue in some countries, highlighting the need for
appropriate reforms of tax systems.
Recent progress in trade liberalization
The creation in the 1970s of a common market applying to trade within the
Caribbean and the elimination of most quantitative restrictions were major
steps in the integration process. The adoption in 1973 of the Common
External Tariff (CET), which applies uniform tariffs to imports from
outside the region, was another significant step toward the integration of
the region with the rest of the world, as were protocols on trade in
services and the free movement of labor and capital within the region.
This liberalization led to an increase in the region's total exports,
particularly of nontraditional commodities, as well as larger
intraregional trade flows.
To accelerate the progress in trade liberalization in line with global
trends, CARICOM countries agreed to a schedule of phased reductions in the
CET starting in 1991. The objective was to reduce the maximum CET in steps
from 45 percent to 20 percent by 1998. Tariff rates imposed under the CET
depend on the nature of the taxable commodity. Most commodities are
grouped as competing (if regional production satisfies at least 75 percent
of regional demand) or noncompeting, and then each group is subdivided
into inputs (primary, intermediate, and capital) and final goods. The rate
structure is 0 or 5 percent on noncompeting inputs, 10 percent on
competing primary and capital inputs, 15 percent on competing intermediate
inputs, and 20 percent on all final goods. (The CET agreement also allows
for a special rate on agricultural products, limited duty exemptions
related to economic development, and some additional national discretion
in the setting of tariff rates.) About half of the countries in the
region—which account for the majority of its trade—have implemented the
final reductions of the CET. Some of the others, especially those with the
smaller economies, have found it difficult to implement the final
reductions, mainly because of their inability to replace lost revenues and
concerns about the ability of their domestic producers to thrive in a more
competitive environment. When revenue considerations permit, the CARICOM
countries should make further cuts in their highest tariff rates to reduce
tariff dispersion and effective protection.
Effects of trade liberalization
How do trade liberalization's benefits compare with its costs? On the one
hand, the benefits accrue because of lower input costs for producers owing
to the reduced tariffs, a wider variety of goods available to consumers at
lower prices, and enhanced export prospects as employment and output
increase in the exportable goods and services sectors. On the other hand,
tariff cuts could lead to a reduction in output and employment in certain
sectors that face greater competition from lower-cost foreign products.
The net outcome invariably depends on the structure of the economy and the
flexibility of wages and prices to allow the full readjustment of relative
prices following trade liberalization. In most countries, the beneficial
effects are likely to predominate.
For the Caribbean region, preliminary evidence suggests that trade
liberalization has brought significant net benefits. After trade barriers
among countries in the region were removed in the 1970s, the reductions in
the CET were expected to lead mainly to increased imports from countries
outside the region and—as trade liberalization led to a more efficient
allocation of resources—increased exports. Imports by CARICOM
countries—both from other CARICOM countries and from countries outside the
region—have increased, as a percentage of GDP, since cuts were made in the
CET (Table 2). Although total exports from the region have also grown
since liberalization, they have not increased as rapidly as imports. A
major constraint on growth of the region's exports has been the decline
since 1994 in commodity exports, particularly banana exports from the
Organization of Eastern Caribbean States (OECS) countries, because of bad
weather and the loss of preferential access to markets. Nontraditional
exports, including agricultural produce (but excluding sugar and bananas),
increased over the period, with countries moving toward greater
specialization by producing goods and services in which they have
comparative advantages, such as tourism.
By allowing prices more closely to reflect
production costs, trade liberalization has brought about a shift of
resources to sectors in which Caribbean countries have comparative
advantages. The exportable service sectors have expanded, with tourism and
information services growing to about 40 percent of GDP in 1998 from about
25 percent in 1994. Some exportables sectors have contracted, however,
because of greater competition from producers outside the region and from
trade agreements elsewhere in the Western Hemisphere, such as the North
American Free Trade Agreement (NAFTA), which extended trade preferences to
Mexico but not to the Caribbean region. An example is the garment
industry, which expanded rapidly in the 1980s but started contracting in
the 1990s as trade liberalization intensified.
Finally, trade liberalization improves the welfare of a country's people.
Apart from the wider variety of goods that become available, indications
are that these goods are available at lower prices than previously. The
import content of the baskets of consumer goods and services used in all
of the Caribbean countries is very high—ranging from about 75 percent in
St. Kitts and Nevis to 50 percent in Jamaica. After one adjusts for policy
changes that could make comparisons misleading—such as fiscal measures
involving increases in taxes on imports—the available evidence suggests
that the domestic prices of Caribbean countries' imports rose more slowly
than before-tariff import prices.
Available data indicate that trade liberalization has contributed to
greater overall investment in the region. Although investment as a share
of GDP varied considerably among countries, total investment for the
region rose to 281/2 percent of regional GDP in 1998 from 261/2 percent in
1994. Foreign direct investment increased to 61/2 percent of regional GDP
from about 41/2 percent during the same period. The reduction in tariffs
helped reduce the costs of capital and intermediate goods that are crucial
to expansion of the manufacturing sector in the region's larger
economies—Barbados, Jamaica, and Trinidad and Tobago.
Revenue effects and further tax reform
Because international trade taxes—such as customs duties and service
charges—are major sources of revenues for most CARICOM countries, the
effects on revenue of reductions in tariffs are important (see Ebrill and
others, 1999). Trade liberalization led to a reduction in the overall
ratio of import duties to the value of imports, as measured by the
collected tariff, to 61/4 percent in 1998 from about 81/4 percent in 1994.
Tariff revenue fell to 41/2 percent, from about 41/4 percent, of GDP even
though the value of imports rose to 46 percent, from about 40 percent, of
GDP during the same period.
Trade liberalization and the likely loss of revenue resulting from it make
it imperative for Caribbean countries to undertake further tax reforms.
These reforms should concentrate on broadening and strengthening domestic
taxation, as well as harmonizing taxes across the region to achieve closer
economic integration and easier administration. Efforts should be made to
harmonize and strengthen domestic sales taxes, as was done in Barbados and
Trinidad and Tobago, where value-added taxes replaced the existing, poorly
structured consumption and special services taxes. In many Caribbean
countries, existing consumption taxes tend to exclude services and
distributive margins, and to cover the services sector—the most rapidly
growing sector in their economies—either poorly or in a distortive way.
As a first step for those countries without a value-added tax, the
consumption tax could be reformed so that it more closely approximated a
value-added tax—that is, became similar to the general consumption tax (GCT)
in Jamaica or other value-added taxes in the region. Adoption of a
well-structured value-added tax would help eliminate distorting effects on
consumption and production decisions, remove cascading of taxes (multiple
taxation of the same good as it is resold up the production chain—for
example, moving from importer to wholesaler to retailer), and relieve the
tax burden on exports of goods and on the use of capital goods. However,
to ease administration, the value-added tax should allow for a threshold
below which small taxpayers would not be obligated to register for or pay
the tax. Also, excise taxes could supplement broad-based consumption taxes
in countries' systems of taxation and should apply equally to domestic
production and imports (and should be rebated on exports). They should be
confined, however, to a narrow range of products—such as alcohol, tobacco,
and petroleum—that would yield substantial tax revenues (see IMF, Fiscal
Affairs Department staff, 1995).
Trade liberalization has provided the Caribbean countries with increased
opportunities, but their progress has to be assessed in the context of the
trade liberalization that has occurred elsewhere. If their external
competitiveness is not to be eroded, the Caribbean countries will need to
liberalize trade as quickly as countries in competing regions (especially
Central and South America). Because trade liberalization may increase
competition from abroad and lead to the loss of some preferential trading
arrangements, it must be accompanied by reforms to improve productivity
and reduce costs if Caribbean countries' market shares are to expand.
Price and wage flexibility is therefore needed to allow resources to be
used more efficiently following trade liberalization.
Finally, it must be emphasized that the most important component of trade
liberalization is the reduction in the overall level of tariffs. If a
reduction in the CET is offset by other taxes on trade (stamp duties,
import surcharges, and discriminatory domestic consumption taxes) because
of concerns about possible revenue losses, then the hoped-for benefits may
not be forthcoming. Policymakers should therefore address revenue concerns
by reforming countries' tax systems, including, most importantly,
replacing existing consumption and special services taxes where necessary
with value-added taxes, reducing duty exemptions, improving tax and
customs administrations, and harmonizing taxes across the region.
Liam Ebrill, Janet Stotsky, and Reint Gropp, 1999, Revenue Implications of
Trade Liberalization, IMF Occasional Paper No. 180 (Washington:
International Monetary Fund).
IMF, Fiscal Affairs Department staff, 1995, "Domestic Consumption and
Production Taxes," Chapter 3 in Tax Policy Handbook, ed. by Parthasarathi
Shome (Washington: International Monetary Fund), pp. 71-118.
Janet Stotsky is a Senior Economist in the Caribbean II Division of the
IMF's Western Hemisphere Department.
Esther Suss is a Senior Economist in the Caribbean I Division of the IMF's
Western Hemisphere Department.
Stephen Tokarick is an Economist in the Caribbean II Division of the IMF's
Western Hemisphere Department.