«Productive Development Policies in Jamaica Mónica Panadeiros Warren Benfield Inter-American Development Bank Department of Research and Chief ...»
EFZs implied a considerable fiscal effort but did not help to boost exports or to diversify the economy. On the contrary, the innovative approach of JTI –although too early to be properly assessed—seems to follow modern principles of industrial policy development: as a discovery process—one where firms and the government learn about underlying costs and opportunities and engage in strategic coordination.
Beyond the critical appraisal of EFZs and the cost-benefit analysis suggested, a relevant issue in the discussion of this PDP is its compatibility with WTO rules. Related to this, Export Industry Encouragement Act and the Jamaica Export Free Zones Act have been brought before the WTO as containing export subsidies. Jamaica was in the first instance expected to eliminate its export subsidies by the January 1, 2003 in order to be in compliance with the requirements of WTO’s Agreement on Subsidies and Countervailing Measures. Pursuant to Doha Ministerial Decision on implementation, Jamaica however received an extension which expired on December 31, 2004. The extension is renewable annually under fast-track procedures subject to transparency and standstill requirements.
5. Summary and Conclusion Historically, the Jamaican economy has had an agricultural base. New economic developments began with bauxite mining (after 1952) and the tourism boom in the 1950s and 1960s. However, brisk economic growth in these years was followed by modest performance over the last two to three decades. Despite the structural reforms implemented in the 1990s,61 however, the current GDP per capita at constant prices is roughly the same as it was in 1970, when only few sectors have been dynamic (tourism, telecommunication and bauxite) and unemployment rates have remained above 10 percent of the labor force.
The causes are complex, but behind such a poor performance has been the heavy burden imposed by a long history of high public debt. High debt requires increased tax collection and external borrowing, and it may also have helped to keep interest rates relatively high.
However, these market-oriented reforms were incomplete: the State still plays a large role in the economy.
In addition, the “debt overhang” appears to have very little effect on investment, the usual channel through which debt affects growth, but rather skewed it towards safer but lower-return activities and industries. Actually, investment rates are high—averaging over 25 percent of GDP in the last 15 years—as Jamaica has been attracting FDI through a flawed tax system that favors capital expenditures, even when they are not very productive. High investment can also reflect an inefficient substitution of capital for labor due to rising and high real wages—pushed by powerful trade unions—and labor market rigidities. The trend of high investment rate and low growth has implied a decline in productivity of 0.5 percent a year from 1960 to 2000, compared to a 0.9 percent increase for the world average (Downes, 2004).
Furthermore, high debt services and generous tax incentives to investment (tax expenditures) limit the government’s ability to channel funds into social and physical infrastructure. Given the complementarities between public and private investment, countries with very low public investment, such as Jamaica, appear to grow more slowly, even if private investment remains high.
Though there are other possible reasons for the coexistence of a relatively high investment/GDP ratio and low economic growth, such as the underestimation of GDP due to the increasing significance of the informal sector; or that much of the capital created in the early 1990s has been to protect against crime; the great levels of emigration of the most skilled labor force; or the macro volatility and constraints on growth caused by natural disasters (hurricanes and floods), it is likely that high debt and tax incentives for investment are key explanatory factors.
The complicated and comprehensive incentive schemes undoubtedly dominate the industrial policy of the country. Jamaica, like most other Caribbean economies, followed this policy inspired by the strategy known as “Industrialization by Invitation” formulated by Nobel Laureate Sir Arthur Lewis. Lewis thought that the limited amount of islands trade prevented these economies from exporting on a competitive basis because they could not afford incurring the cost of breaking into established export supplier markets. Instead, he recommended that these small countries should, through a series of incentives, attract foreign entrepreneurs to install and open their businesses and factories in the islands. Foreign capital was therefore viewed as a means of overcoming limitations to industrial development imposed by the small volume of trade of Caribbean economies.
In addition, foreign capital would contribute to the acquisition and development of fundamental managerial, entrepreneurial and administrative skills that were absent in newlydeveloping economies. Over time, after a learning period, it was thought that local entrepreneurs would possess the capacity to start their own ventures and the creation of their respective national industrial bases.
English-speaking countries, following these proposals, passed a series of fiscal legislative incentives upon gaining their independence. They also formed a regional integration scheme (CARICOM) that provided the framework for a customs union and, at least during the 1970s, a common regional approach to industrialization and tax incentive polices. The regional policy of fiscal subsidies was formalized in the Agreement for the Harmonization of Fiscal Incentives (1973). The agreement conceived fiscal policy as a microeconomic tool providing incentives to promote industrialization and to develop the mining and tourism sectors. While the legal framework was conceived at the regional level, its implementation was carried out at the national level.
In the case of Jamaica, its tax system includes an extensive set of incentives for investments, many of which have accumulated over a period of more than half a century and are accessible to local and foreign investors. Typically they provide relief from income tax on earnings as well as concessions on import taxes and duties to eligible enterprises for a period of time that may range up to fifteen years, while some incentives provide other benefits such as capital allowances. Many incentives are specific to particular sectors; the most benefited ones are tourism, industry, bauxite and mining, agro-processing, creative industries, shipping and ICT, all of them strategically selected by the government through different economic development plans.
Some generous investment incentives are granted through the EFZs, one of the main instruments for promoting non-traditional exports to third markets. The "free-zone" status enables manufacturers and service providers to benefit from the indefinite exemption from income tax on profits as well as import duties, licensing and quantitative restrictions, with customs procedures being reduced to a minimum.
Therefore, since the 1970s and 1980s, Jamaica’s industrial policy of Jamaica was based on two pillars: granting selected tax incentives to attract FDI and/or as part of an export promotion strategy. The complex system of tax incentives distorts the actual structure of taxation, with the result that the private sector in Jamaica is relatively highly taxed on one hand, or not taxed at all on the other. The implied allocation of capital is very inefficient: taking into account the level of interest rates, in sectors without subsidies, investment projects require that productivity be extremely high; in other sectors, productivity could be so low as to allow even negative rate of return projects.
Beyond the distortions generated by such a policy, the dedicated tax expenditures, and the extensive informality induced in non-favored sectors, it has contributed to rent-seeking behavior and corruption. Previous studies have shown that the prevailing paradigm for public-private dialogue in Jamaica has been predominantly informal, with an alarmingly high amount of ministerial discretion in the provision of exemptions for tax and customs.
The analysis of the effects of the tax incentive policy suggests that this strategy seems to have been successful in attracting foreign capital. However, the performance is not so impressive when compared to the evolution of worldwide and regional inward FDI flows. In addition, as in the rest of the English-speaking Caribbean, the export growth of the dynamic sectors has not been sufficient to offset the underperformance of the declining ones, and EFZs have contributed poorly to market diversification.
From an analytical point of view, there is growing skepticism about the traditionally wellaccepted view among economists and policymakers that attracting FDI is essential for economic growth and development. The empirical literature is not conclusive about the positive externalities to the rest of the economy which might justify the promotion of both foreign investment and exports. On the other hand, with the benefits of EFZs are more related to agglomeration than to tax breaks, which make this tool a possible channel for cluster development (considered a source of positive externalities).
In developing countries, EFZs have been seen as the response to government failures:
EFZs can play an important role in attracting FDI by offsetting some aspects of an adverse investment climate, through offering world-class facilities and best practice policies. 62 Three decades of zone development experience suggests that the use of generous incentives packages to offset other disadvantages is ineffective in terms of overall zone performance, due in large to the increasing commonality of zone investment incentives in recent years.
The EFZs can also be seen as a policy to “try” an open economy within a no so open environment, but in this case, the EFZs should be a transitional policy, not a permanent one.
These results make the case study more relevant. A preliminary assessment suggests that the Jamaican economy does not escape the general pattern: strong examples of the hypothesis of low spillovers are the very few linkages found between tourism development and local communities, and between firms in the EFZs and the rest of the economy. On the other hand, crime and inefficient government bureaucracy appear as the most problematic factors for business growth, and both obstacles are relatively addressed through EFZs facilities, without even compensatory measures as tax breaks.
The controversial empirical evidence about the benefits of the tax incentive policy to attract FDI suggests that if the amount of tax expenditures associated with this program is supposed to be high, as it is in the case of Jamaica, it would be worthwhile to carry out a costbenefit analysis of this policy.63 At present, an extensive review of proposed tax reform measures is underway, taking into account previous tax reform studies. The Foreign Investment Advisory Service was asked to assist in the review, and among the proposals advanced are a reduction of the corporate income tax rate to 25 percent and the elimination of all tax holidays. However, the government of Jamaica is reluctant to do this. Even though they were introduced in response to perceived market failures in the past, fiscal incentives are very difficult to dismantle because of strong lobbying by rent-seeking organizations.
While export promotion and foreign investment attraction continue to constitute the most relevant policies carried out presently, since the beginning of the present decade a new set of PDPs has been put in place. Most of these policies share with the traditional ones the vertical approach: they are focused on specific areas, sectors, and industries. However, they seem to respond to the most modern vision of industrial policy: they involve a closer and formal approach to public-private dialogue, they promote clustering in sectors that already show some comparative advantage, and they try to address coordination and information failures.
One example of this new generation of policies is the Master Plan for Sustainable Tourism Development, formulated in 2003. It was designed as a two-stage process to facilitate consultation to build consensus on the direction in which the industry should take. Recognizing that the key to improving the competitive position of Jamaican tourism is greater diversification, IDB (2007) simulated a scenario where the statutory rate was reduced to 20 percent, but at the same time taxincentives and deductions were eliminated for some “targeted” sectors (communications, electricity, construction, and tourism/hotels). Under these conditions, it was possible for the economic outcome to be positive: short-run output increased by 0.4 percent annually and long-run output rose by 3.8 percent.
the plan emphasizes the forging of stronger linkages between tourism and other productive sectors, greater community involvement, showcasing of Jamaica’s culture and heritage, and event-led promotion. It is considered that a sustainable market position must be based on Jamaica’s heritage, which is natural, cultural, historic and built. In this way, this PDP aims at fostering the leakages of tourism to the rest of the economy.
The apparent coordination failures that the Master Plan aims to address seem to arise from the perceived desirability of differentiating Jamaica from other similar places in the region by focusing on its culture and heritage, which requires greater involvement of local communities.
The plan highlights the importance of creating linkages between the tourism industry and other sectors, through minimizing leakages (food, drinks, linens, towels, etc.). This is an area where self-discovery externalities must have been preventing the development of certain activities. It is likely that some goods could be locally produced in a profitable way, but learning “what and how” requires investments whose social value exceeds their private one. The national agency of investment and export promotion, JTI, is working on this area through the development of its own initiatives. For example, JTI has developed a strategic relationship with hotel chains within the country, and is working to establish a reliable supply chain to create access to the hotel market for Jamaican food and beverages suppliers.