How Has The International Monetary Fund Impacted the Caribbean Business Environment

William Franklyn 407002804

THE UNIVERSITY OF THE WEST INDIES

(CAVE HILL) CAMPUS

FACULTY OF SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS

FINA3010 – SUPERVISED RESEARCH PROJECT

How Has The International Monetary Fund Impacted the Caribbean Business

Environment?

Student Name: William Franklyn April 1st, 2014

ID#:407002804

Professor: Mr. Wilberne Persuad

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ContentsIntroduction:...............................................................................................................................................3

Literature Review:.......................................................................................................................................4

Background:.............................................................................................................................................4

Further look at the IMF:.......................................................................................................................4

The World Bank:..........................................................................................................................................5

Loans facilities offered by the IMF:..........................................................................................................5

Definition of Caribbean Business Environment (The Small Open Economy Model):...................................6

Characteristics of the Caribbean Business Environment:........................................................................6

Definition of a Financial Crisis:.....................................................................................................................7

What causes a Financial Crisis to occur?.....................................................................................................8

Conclusion:..................................................................................................................................................9

Descriptive analysis...................................................................................................................................10

Methodology.............................................................................................................................................15

Conclusion.................................................................................................................................................16

Social Instability:....................................................................................................................................16

Further look at the impact of the IMF’s procedures/objectives:.......................................................16

Potential Threat.....................................................................................................................................17

Policy Responses:......................................................................................................................................18

Internally:..............................................................................................................................................18

Externally:..........................................................................................................................................18

Bibliography:.............................................................................................................................................20

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Introduction: This research paper aims to analyze the process of The International Monetary Fund in Barbados

and how the country was affected by their guidelines. Barbados has been said to be one of the

developing countries within the Caribbean Business Environment. However due to external

shocks as well as weak domestic policies, Barbados was forced to ask the IMF for their aid as a

last option, to stabilize the country’s economy. This research paper intends to highlight that the

significance of The IMF as well as the impact as it relates to small open economies.

There will be a literature review informing all of the relevant information pertaining to the

general subject topic. Afterwards, a case study will be presented on Barbados and our findings.

Once all the information has been disclosed, a conclusion will be given with regards to the IMF

and their impact towards small economies.

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Literature Review:

Background:There are three constitutions primarily responsible for global financial stability. These three

institutions are

1. The International Monetary Fund

2. The World Bank

3. General Agreement on Tariffs and Trade known as (GATT)

Further look at the IMF:The IMF was conceived in July 1944. It represents one of the major Bretton Woods Institutions.

The IMF was established to assist countries in their recovery from the ravages World War II

(1939-1944).

This war impacted the major industrial countries of the European. As time evolved other

countries were allowed to join the IMF developing countries.

Role and function of the IMF:The principle function of the IMF is to maintain the global financial stability. It seeks to achieve

this as follows:

By employing stabilisation Policies/Measures: Stabilisation policy refers to short term

measures to bring about adjustments in the economy.

These adjustment measures are as follows:

Exchange Rate adjustment: A mechanism that is used by the IMF to influence a home

currency’s exchange rate. The IMF intervenes in the home currency’s exchange rate to

reduce short-term fluctuations.

Wages reduction or freeze: A mechanism of cutting or reducing employee’s wages during

a difficult economic period.

Reduction in Government Expenditure: Implementing mechanisms to help reduce

Government spending.

Increase in price of credit (increase in tax)

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Removal of price control: The removal of price control when prices on essential items

such as food or oil are rising rapidly.

Stabilisation policy focuses on the demand size of the economy. Reduce demand by shifting the

curve inward.

The World Bank:World Bank is responsible for structural adjustment: It seeks to achieve this by employing

structural adjustment policies/measures.

Structural adjustment refers to the use of the discreet measures to restructure the economy. It

focuses on the supply side of the economy and it does so as follows:

The reform of the following sectors:

1. Tourism

2. International Business and Finance Services

3. Manufacturing

4. Agriculture

5. Banking and Financial Sectors

6. Trade

7. The Labour Market

Loans facilities offered by the IMF:I. Stand-By-Arrangement (SBA): This is a basic agreement for a short term stabilisation

package usually over a period of one to two years.

II. Extended Fund Facility (EFF): This is a medium term facility to provide balance of

payment support.

III. Buffer Stock Financing Facility (SBFF): This seeks to provide financing to mineral

producing countries to support commodity prices.

IV. Emergency Assistance Facility (EAF): This provides funds to member countries in time

of disasters. This is usually covered by the Caribbean Catastrophic Risk Insurance

Facility.

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V. Poverty Alleviation Facility: This facility is offered to member of countries that

experience abject poverty.

VI. The Flexible Credit Lines: This facility is offered to member countries that need a faster

access to credit.

Definition of Caribbean Business Environment (The Small Open Economy Model): According to A. Wendell (1986) he defines a small open economy as an economy which engages

in free economic intercourse with the rest of the world under conditions on which there are

unable to influence the relative prices of imports and exports. As a result, Caribbean economies

are price takers; they are very similar to a firm operating in a perfectly competitive market

environment.

Characteristics of the Caribbean Business Environment:According to Mr. William Demas (1960’s) he said the Caribbean is structurally dependent and

that is because of their small size. He further explained that their dependence is as follows:

Financial dependence

Technological dependence

Industrial dependence

Trade dependence

Dos Santos also added to this discussion of dependence, he said that dependence is a situation in

which the development and expansion of a country is subjected to the development and

expansion of another country.

Since the Caribbean countries are striving for growth. Sir Arthur Lewis (1954) sought to develop

a dual sector development model which sought to explain how development can take place. In

this model two sub-models were developed:

1. Unlimited Supply of Labour Model

2. Industrialization by Invitation Model

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Unlimited supply of Labour Model: he explained that this model consists of two sectors: The

substance sector and Capitalist sector. The substances sector, the economy does not utilize

reproducible capital whereas; the capitalist sector is where the economy utilizes reproducible

capital and pays (rewards capitalist for their efforts.)

Industrialization by Invitation Model: Lewis argued that in the economy where the savings rate is

low then it is necessary to invite foreign capital into your country.

In this model, he indicated of the benefits gained if this model was taken into consideration:

(Local) workers can learn managerial skills

Technological transfer: where technology would be transferred from the foreign country

to the host country.

The development of infrastructure.

In exchange, FDI contribute to the tax (corporation income) revenue for the Government.

Definition of a Financial Crisis:According to the IMF World Economic Outlook (1997) a Financial Crisis is an event within an

economy which disrupts the conduct and operations of the economy to the extent that it results

on significant financial disruption. There are various types of financial crisis:

Banking Crisis – Depositors suddenly start to withdraw their funds.

Balance of Payment Crisis – Total Exports Significantly exceeds total exports.

Debt Crisis – National Debt; country has a debt to GDP ratio in excess of 80%.

Fiscal Crisis – is a situation where a government cannot finance its regular activities,

including providing social services, paying for defence, and managing other government

functions.

Exchange Rate Crisis – This occurs when one country’s money becomes rapidly

devalued relative to the international system.

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Economic Crisis – is a state in which dramatic shifts in the economy create severe

hardship for everyone connected with that economy.

What causes a Financial Crisis to occur?According to Gafar (1996) he believed that at the macro level, financial crises were caused by a combination of inappropriate domestic policies and external shocks, According to Santella (1996) research, weak payments, low output growth, tough economic conditions and expansive financial policies were indicators of a financial crisis.

According to the International Monetary Fund (IMF)(1998); the IMF argued that the causes may be grouped under the following:

Unsustainable macro-economic policies for example debt accumulation and overly expansive monetary and fiscal policies.

Poor financial structure. Financial conditions on a global scale. Political instability. Exchange rate misalignments.

Kaminsky and Reinhardt (2000) explained that financial crises occur as economies enter a recession following a booming economy fuelled by credit expansion, capital inflows and accompanied by an overvalued currency.

Demirguc-Kunt and Detrigiache (1998) based on the authors’ research during the period 1980-1994; they have identified the causes of financial crises as weak macro-economic environment that is, high inflation and low growth.

Conclusion:The literature presented outlines a clear view of the IMF’s structure; it informed the focus of the

IMF as well as their objectives. The literature also explained the Caribbean business environment

and the characteristic of what defines a Financial Crisis and why the IMF is considered.

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Descriptive analysisBased on the literature, one of the most dominant and developing countries in the Caribbean

Business Environment who invited the IMF for their assistance was Barbados.

Barbados’ economy had faced several shocks for approximately 25 years, this was due to a

reduction in output, weak external balance and high inflation. The rising of oil prices in 1973, the

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global recession and high interest rates in the 1980’s and the impact of the Gulf War in the early

1990’s all had a direct effect on the Barbados economy. In the domestic area around the time for

elections, the various mechanisms that were implemented had a relationship to the economy’s

downfall. This was done by means of cuts in tax rates, increased expenditure on wages within the

public sector structure and unfortunately, due to these practises over the years, this led to an

increase in lending to the public sector by the Central Bank.

Barbados entered into the IMF programme in 1982, Barbados entered into a Stand-By-

Arrangement (SBA). In 1991, Barbados entered into an Enhance Structural Adjustment Facility.

This was a medium term programme.

The reason for joining this programme was because of the challenges Barbados faced the

following challenges at a macro level:

1. Fiscal Disequilibrium 1991.

2. 7.4% of GDP.

3. Net International Reserves (NIR) was 13/4 weeks of imports.

4. Unemployment was at 14%.

5. Inflation rates were at a high of 8%.

In September 1991, the IMF was invited by the Government of Barbados to assist during the

financial crisis of the country.

The Enhance Structural Adjustment Facility was utilized for several purposes to help stabilized

the country’s economy:

Components of the ESAF:

Reducing the Government’s expenditure which was done by means of:

8% wages cut: The Government’s adjustment implied the necessity of lower private

sector wage settlements by limiting the 1982-1984 public sector wages to an average of 7

per cent per annum.

Job entrenchment (3,000 Public Servants): October 1991, an adjustment was made

recommended by the IMF to cut basic wages of public employees by 8% and reduce the

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public workforce by 3000. Taxes were increased to reduce the disposal income and as a

result, increased contributions and income ceilings for unemployment insurance. Taxes

were implemented to pay on severance costs of public workers who were not covered by

the severance scheme.

Increasing revenue measure which was done by means of:

Increase taxes on income: Government phased out the tax-free on domestic

manufacturing products and temporary payroll tax was introduced. Tariffs and user fees

were implemented on public transportation, water; housing and natural gases were

increased.

Further to the adjustment, Government sold its shares in the telecommunications sector

(privatisation) and in manufacturing to realize the foreign exchange when reserve

holdings were very low.

Introduction of stabilisation tax of 3% of all salaries

Last but not least reducing the Fiscal Deficit by means of:

Halt/Freeze in capital works programmes: In 1992 programme the fiscal adjustment was

achieved due to the combination of the impact of wage freezes and low capital spending

by Government.

Increasing in credit

Credit expense:

According to Haynes C (1997) Stabilization Programmes are geared at correcting fiscal and

extending imbalances with the common view of placing the economy on sustainable growth. The

programmes introduced by the IMF were a stabilisation phase which went on for approximately

18 months (1991-1993). At the end of the 18 months period the fiscal deficit was down by 3%

and Barbados regained financial stability within the economy.

After the stabilisation phase this ended in 1993. The Structural Adjustment Phase commenced.

Major reforms were proposed especially to the productive sectors such as:

Tourism

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Manufacturing

Agriculture

International Business and Financial Sector

Public Sector Reform

Labour Market

Banking & Financial Sector Reform

Trade Reform

Two abstract tables were taken from Haynes, C. (1997) Central Banking in Barbados: Reflection

& Challenges. The reason for the abstract was to clearly highlight economic indicators of

Barbados financial instability at the inception when Barbados invited the IMF for aid in 1982.

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MethodologyIn this research paper, what is being pursued is an understanding of the IMF process as it relates

to a Caribbean country, and what was the primarily focus during the various steps to strive for a

better economy. The question is whether or not IMF is positively effective as it relates to

responding to a small open economy during a financial crisis. The focus was to obtain as much

information as possible in order to draw to a solid conclusion.

However, there were a few limitations while gathering the information above, this would have

included the lack of availability of authors to discuss different point of views on the said subject.

Unfortunately in most forums, the IMF was mainly discussed with experiences mostly outside

the Caribbean Business Environment.

The method of Historical analysis was used in order to establish facts and ultimately conclusions.

Only secondary data was used. This method was utilized because of the nature of this topic and it

allows for flexibility.

Questions formulated by the researcher:

1. What is the role of the IMF?

2. What impact does the IMF have on small open economies such as Barbados?

3. How has the IMF affect the level of unemployment in Barbados?

4. Is the IMF effective in the Caribbean Business Environment?

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ConclusionThe International Monetary Fund impacted Barbados on the macro. From a macro stand point,

Barbados was able to regain financial stability. On the other hand, socially, these programmes

have also led to a level of instability at the micro level.

To measure the success of these programmes introduced by the IMF, there are very difficult to

assess and this is because of the dynamics involved. A programme which leaves an economy in a

low growth but non inflationary position most likely would be preferred over a destabilizing

inflationary environment which can guide to high unemployment.

Financial Stability speaks to an economy that is heading in the right direction and a pathway

towards economic growth. However, given the information mentioned above, short-term output

and unemployment was negatively impacted during procedures implemented by the IMF.

Social Instability:The techniques introduced to Barbados by the IMF, this led the unemployment rate to increase,

as shown in the abstract table mentioned above according to Haynes C (1997) Government cut

wages by 8% and an estimate of 3,000 public workers were sent home in order to reduce the

deficit. The impact of wages cut was much disliked; this caused regrettably national strikes and a

legal challenge to the authority of action. Additionally, as a result of the use of these programmes

the output was low and this reflected on the increase of job losses, which consequently resulted

to be costly to the Government for example: Government basically started to reduce the labour

force in the public sector; the ripple effect will be mirrored by the private sector. This can

translate to be costly, because Government will be tapping into funds to payout the public

workers who were made redundant, as well as the cost associated to the National Insurance

Scheme (NIS). The NIS would also have to look for funds to pay unemployment workers who

were laid off from the private sector and less output/productivity can lead to a bottleneck in the

development within the economy. Adjustment output was achieved only in 1996.

Further look at the impact of the IMF’s procedures/objectives:According Haynes C (1997) The IMF programmes focus on two types; The Quantitative

performance criteria which deals with more of the general macro-economic indicators. In

addition, they look at Quantitative targets which impose discipline on policymakers and serve the

purpose of solving liquidity problems.

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The IMF policy focuses more on the macro variables unlike the micro variables. This was

evident based on the programme (ESAF) which was utilized in Barbados. This would have

eventually led back to social instability.

The IMF does not focus enough on the income distribution policies. In addition, the monetary

policy criteria are limited. Given the circumstances and evidence, this researcher believes that

IMF does not understand how small economies work and they believe that every situation, the

procedures that are applied, it is a one size fits all concept. What may have worked for the bigger

economies abroad for example the United States, does not necessarily work with the small

economies in the Caribbean.

The International Monetary Fund can be described as a one-track mind, their programmes are

relatively short. This can affect the country due to the fact, that the IMF may believe their

process to be a dominant factor and will fit any economy regardless of the type of crisis. This

begs to question Are they not taking into consideration other factors that may pose a small

negative deviation but still impactful? In this research it suggests based on the case study above,

that the IMF is just here to complete a job, it does not matter how and what was taken into

consideration, once the job is completed and the aims/objectives have been met according to

their time and policies.

Potential Threat:

The increase in unemployment could have led to an increase in the level of poverty and

consequently, causing an increase in crime. This could have impacted the island’s ability as a

tourist attraction. Barbados does not have a competitive advantage over other small economies

that may produce items like oil, fish, gold or bauxite. It was reported that our exports of sugar

cane declined. Therefore, the island’s main resource is serviced based and without the human

resources our dependency on tourism would significantly decline especially, for the survival of

foreign exchange. In addition, a decline of access to social services can contribute to staggering

economic growth.

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Policy Responses:It is recommended that prevention is better than cure i.e. preventing the economy from having to

go to the IMF.

Internally:Prudent economic policies should be in place: where the country creates a policy that maintains

proper balance borrowing, expenditure and saving. Having minimal fiscal deficit so that

borrowing becomes less, Government does not have to print excess money and controlling

revenue and capital expend so that economy grows properly and the growth leads to more job

creation by public and private sectors.

Fiscal Discipline: (below 3% of GDP): this would require governments be cautious about the

extent to which they rely on loans to finance a deficit. So in other words it is important, because

if government relies too much on loans to finance current expenditure it will accumulate large

future debt and interest obligations will in turn undermine its capacity to spend on goods and

services.

Externally:The Caribbean should move together and become a greater voice, in order to discuss the issues

that are faced and so that it has a better chance of being heard.

If the Caribbean is apart of the decision-making process, this would make the process a lot

easier, the concerns and views will be made known, two heads are better than one and the IMF

may finally understand how the small open economies work.

Recommend that the IMF programme be extended longer.

A reform of the Bretton Woods Institution: going back to the drawing board and making policies

more flexible due to the various types of situations.

Increase special drawing rights: The (SDR) is neither a currency, nor a claim on the IMF. It is

however, a potential claim on the freely usable currencies of IMF members.

It must be noted, if Barbados was to continue with the mixture of external shocks and weak

domestic policies. The Economic stability would have been uncertain. However the IMF did

managed to get the country to a level of solidity at the expense of the various areas within the

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micro level. Despite of the impact, Barbados should be encouraged to learn from these

experiences in order to be more proactive, and aware of the how detrimental decisions can be

when it comes to macroeconomics verses the microeconomics because they both make up the

country’s economy.

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Bibliography:Boamah, Daniel and Haynes, Cleviston, Domestic and External Influences on Barbados’ Public

Debt, Codrington, H. Craigwell, R. And Haynes, C (Editors), Central Banking in Barbados,

Reflections and Challenges, Bridgetown Central Bank of Barbados, 1997.

Demirguc-Kunt and Detrigiache (1998): Banking Crises in Developed and Developing

Countries.

Edwards, Sebastian and Montiel, Peter, Development Crises and the Macroeconomic

Consequences of Postponed Adjustment in Developing Countries, International Monetary Fund,

Staff Papers, Vol.36, No. 4, December 1989, pp.875-903.

Gafar, John, Macroeconomics Performanceand External Shocks on Small Open Economies: The

Caribbean Experience, Journal of December Areas, Vol. 30, No. 3, April 1996, pp 341-360.

Howard, Michael, Public Finance in Small Economies: The Caribbean Experience, Praeger,

Englewoods Cliff, New Jersey, 1992.

Kaminsky and Reinhardt (2000): The Twin Crises: The Causes of Banking and BoP Problems.

St. Cyr, Eric; The International Monetary Fund and The East Caribbean States Bulletin of

Eastern Caribbean Affairs Vol.7, No.6, 1982, pp 1-6.

Santaella, Julio, A Stylized Facts before IMF-Supported Macroeconomic Adjustment

International Monetary Fund, Staff Papers, Vol.43, No.3 September 1996, pp. 502-544.

Central Bank of Barbados Official Website

http://www.centralbank.org.bb

The Barbados Economic of Social report 2012

http://www.economicaffair.gov.bb

http://www.imf.org

http://eccb.org

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http://eccb.org/

http://www.economicaffair.gov.bb/

http://www.centralbank.org.bb/


www.cdb.org

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http://www.cdb.org/

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How Has The International Monetary Fund Impacted the Caribbean Business Environment