COMPETITIVENESS IN SMALL DEVELOPING ECONOMICS

ALVIN G. WINT

SUMMARY: CHAPTERS 1, 6 & CONCLUSIONS

Professor Wint first sought to examine certain hypotheses that are usually attached to small economies. These are: -

1. The service orientation of a small economy will be a significant factor in determining the economy’s relative economic performance, with more service oriented economies out-performing their peers.

This is a view held because of the disadvantage of small countries in their ability to leverage economies of scale in the production process.

It is usual to expect that economies of scale are more important in commodity, manufacturing and agriculture and less important in service industries.

2. The level of a country and political risk in a small economy will be a significant factor

in determining that economy’s relative economic performance, with lower risk economies out-performing their peers.

Small economies cannot really attempt autarky (self-sufficiency) given their narrow resource or factor base.

It will be expected that if economic development is to take place a small economy has to integrate itself into regional or the world economy,

i.e. export what it is best at and import the rest, benefit from specialisation.

But in so doing it could become a highly vulnerable economy subject to the vagaries of the world market.

Hence, it appears that such an economy should offset its international risk by minimising the risks associated with the local environment;

for example, it should provide a local climate that encourages investment.

Thus low levels of political and country risk appear to be essential to prosperity among small economies.

3. The level of macro-economic risk in a small economy will be a significant factor in determining its relative economic performance, with lower risk economies out-performing their peers.

Small economies with high risk because of macro-economic instability will, for example, see their residents investing abroad to protect the value of their assets.

Hence, one of the important aspects for macro-economic stability could be the maintenance of the value of local currency vis-à-vis the international currencies i.e. exchange rate stabilisation.

4. The quality of the infrastructure in a small economy will be a significant factor in determining its relative economic performance, with economies with better infrastructure out-performing their peers.

The kind of infrastructure will have a significant impact on the ability of the county’s firms to perform successfully.

Foreign Direct Investment would need quality infrastructure if it is to invest in these countries.

5. The quality of the human infrastructure in a small economy will be a significant factor in determining its relative economic

performance, with economies with better educational levels out-performing their

peers.

The quality of the human infrastructure, leading to the availability of advanced factors and their related physical infrastructure would appear to influence the kind of innovative and entrepreneurial activity in the country.

Professor Wint did a series of statistical tests across thirty countries with populations between one and five million.

The study used per capita income as a proxy variable for the economic performance of the country.

Other variables that were used were exports of goods and services as a percentage of GDP, which included the part that tourism played.

Others were average inflation, paved roads, percentage of age groups enrolled in secondary education, international country risk guide (World Bank).

Another test was conducted to assess the extent to which size mattered in relation to income differences across the countries.

ResultsThe study confirmed that there are no systematic

differences in economic performance between small and larger countries though the economy of small countries may indeed be more vulnerable.

However, the tests demonstrate that this vulnerability is not captured by per capita income data.

Also, the results suggest that small countries need to be cautious about the conventional wisdom that says that the most important factor in improving relative economic performance is the extent to which the activities can be directed towards exports.

Like Porter, Wint sees that an export orientation that does not increase the economy’s average level of productivity is not likely to lead to increased economic welfare.

This is not to say that exporting is not important but what is important is the extent to which exporting adds, on a net basis to national income, in relation to total production of goods and services.

The analysis also suggests caution with respect to the importance of service orientation over, say, manufacturing.

Again, a country may shift towards services which are not representation of an overall increase in productivity within the economy.

Hence services does not necessarily lead to productivity increases in small countries.

What Professor Wint found to be particularly important was the need to reduce risk, and, improving infrastructure as mechanisms for improving relative economic performance.

Given the vulnerability of small economies it is critical that the associated risk that depends on the country’s size outside of the country’s control not be magnified by national-level, controllable risk factors.

However, the analysis did not demonstrate, surprisingly, that education played an important role in differentiating among high-and low-performing small countries.

For a set of larger countries the variables that were significant in explaining the variations in income levels were again the level of the country risk and, differently, the education level of the country’s citizens.

In the combined sample of both small and larger countries, the significant variables were country risk, education and infrastructure.

Application to some Caribbean Economies.

The Caribbean small economies that have performed well in per capita income, have all developed successful tourism and international financial service industries, a worldwide pattern of small economies.

The first and over-riding factor has been the differential levels of macro-stability in the form of economic, political and social stability.

- many small Caribbean economies have maintained macro-economic stability around a fixed exchange

rate with open foreign exchange windows.

- political and social stability have also been evident in the economies that

have performed well.

The macro stability has been essential to the growth of the two dominant industries; tourism, financial services.

- economic success reflects the ability of these countries to play hosts to foreign residents (tourism) or disembodied foreign capital (offshore financial services).

Consider that the Cayman Islands and the Bahamas each attracted thirteen tourists per person.

Jamaica attracted fewer than one tourist per person.

The Bahamas was the largest euro-leading centre outside of London and Zurich and was responsible for 10% of the global euro market.

Bermuda with its ten tourists per capita, is a world leader in offshore insurance and boasts one of the world’s highest per capita incomes.

Cayman’s very high per capita income is due to the aggressive programme of international company registration; registering over 40,000 companies per year in the late 90’s in addition to its 13 tourists per capita.

The down side is that many of these economies have been listed as tax havens by the Organisation for Economic Co-operation and Development (OECD),

so described because the OECD agrees that they are engaging in harmful tax competition and divesting taxable income away from the OECD member countries.

Hence several of these Caribbean countries were involved in efforts to upgrade their international financial service policies and laws to seek conformance with OECD guidelines.

It would appear then that income levels across these countries were based upon their level of integration into the world market. i.e. seeking lucrative niche markets.

In fact, this meets with Kenichi Ohmae’s comment that the money is in the global market and economic success depends on how a country can integrate its economy into the global market.

FDI-Driven Competitiveness.

Professor Michael Porter has talked about the importance of foreign investment in a developing country.

But also noted the fundamental importance also of a timely shift to the use of local investment if the economy is really to become robust and competitive.

He gave the examples of Singapore and Ireland that benefited tremendously in the beginning from foreign investment, but thought that the shift to local investment has been too little too late.

The discussion on foreign direct investment focuses on two inter-related sets of questions.

One of these is why firms invest overseas and the other, what factors determine which countries receive the investments from these firms.

FDI can be classified under the headings; extractive or resource, seeking investment that involves investments to extract natural resources (e.g. T&T, Jamaica);

market seeking or domestic-oriented investments that focus on the domestic market of a foreign country (e.g. Japanese investment in the US, American investment in Japan);

export-oriented FDI that seeks to use a foreign country as a platform in which the firm produces for export to regional or global markets;

or factor-driven investments where a multi-national may invest in a foreign country to benefit from its lower production factor costs.

For market seeking investments, the critical factors are market size, income levels and growth rates.

For export-oriented investment, market growth rate and income rates are also important, but, fiscal incentives and investment promotion take on important roles.

(E.g. the creation of technological parks and the like that aim at attracting foreign investment).

Clearly in the last case, infrastructure quality and the ease by which profits can be repatriated, become important.

Where market size, growth rate and income levels are important, FDI will flow to developed countries.

For extractive FDI, the locational advantage of countries are high on the list of firms seeking ownership advantage in these countries.

These countries are in a relatively strong bargaining position and this position is strengthened once fixed investments are put in place.

Market imperfections like trade barriers in, say a regional market, increases the locational advantage of the nation in seeking FDI;

these barriers are what encouraged the influx of FDI into developing countries during the days of import-substitution industrialization.

FDI flows to countries may also be influenced by government policies with respect to incentives and promotional efforts which may offset, say, locational disadvantages of the country.

Given the amount of effort we are putting into the development of the Tamana Science and Technological Park, it is useful to examine the impact of promotional efforts on attracting FDI in the past into the Caribbean.

Jamaica was involved in enticing Asian investors during the 1980’s.

These investors were seeking access to country quotas that would allow them to export into the US under the Multi-Lateral-Fibre arrangements under which, then, Jamaica had a generous quotas for garment export.

These investors were encouraged by fiscal incentives through the Export Industry Encouragement Act for non-free-zone exporters coupled with the building of factory shells, technical consultancies in garments and negotiating access to the US markets.

The Jamaican garment industry declined in the 1990’s due to the loss of Jamaican advantage due to Mexico’s accession to NAFTA.

Jamaican then sought to target information technology investors. One of the firms that had promised to create jobs in this area went bankrupt in 2001, one that had benefited from government loans.

T&T sought export-oriented FDI initially as joint venture partners to develop its relatively considerable gas resources.

There was a certain amount of success in attracting joint venture investment into iron and petrochemicals.

The government of T&T was able to convince investors to locate in T&T given the availability of cheap natural gas and its location to North American market.

However, some of the joint venture partners of the steel/ iron plant pulled out leaving the government as the sole investor based on envisaged competition of the new arc-furnace mini-mills.

It is fair to say that, coupled with the location and the resource availability, the government did indeed do a lot of direct marketing of the country in this area.

Today T&T has a relatively massive gas based energy sector; largest exporter of methanol and ammonia; largest exporter of LNG into the US and is contemplating the building of three aluminum smelters.

During 1984 – 1989 with liberalisation and promotion efforts, developing countries obtained on average 19% of all FDI.

By 1990 – 1995, the annual average had increased to some 37%.

By the late ’90s there was a sharp reversal to 25%.

Further this flow was concentrated on a few developing countries.

By 1995, the top ten recipients of developing countries that received FDI, got 78%.

The one hundred countries receiving the smallest FDI received 1% of the global FDI.

The trends in FDI inflows suggests that these flows are being concentrated in a group of countries with locational advantages in the attraction of FDI.

These trends are particularly clear since the universal reduction of trade barriers.

The characteristics for attracting FDI are: large markets (China); growing economies and high income levels (besides natural resources).

Singapore and Ireland stand out as being different. Singapore faced locational disadvantages; although it was on strategic shipping lanes it was small, poor and at the time not experiencing rapid growth.

But it was able to attract export-oriented FDI. The important proviso was that at the time Singapore did it, virtually no other developing country was in the market for FDI.

Even so, Singapore guaranteed FDI a specialised rate of return on their commercial activities.

Ireland’s success in attracting export-oriented FDI came in the wake of its 1973 entry into the EU.

Thus for foreign direct investors in Ireland, the market of interest was the world’s second largest market at the time.

Indigenous Firms.

It is important in small developing countries that investment activity is defined so as to include both foreign and local investments and that efforts are used to promote both.

Exchange liberalisation in the Caribbean favoured both local and foreign investment.

However, many developing countries implement promotional activities that favour foreign investment over local investment;

since local investment is a captive entity whereas, governments have to compete among each other for FDI.

Seeing that, again according to Porter, economic development in the longer term depends on the shift to local market investment it is important for governments to give local investors or all investors “most favoured foreigner” treatment.

Determinants of Competitive Advantage in Small Developing Countries.

- Smallness leads to an absence of a diverse range of factors of

production forcing a reliance on the world market for many of the products needed by society.

i.e. the small country does not export its surplus, it exports to survive.

- Smallness leads to an absence of economies of scale which mitigates against resident firms to produce goods and services for the world market.

- Hence, those countries should attempt to offset their inherent scale based risks with a level of stability and quality infrastructure that encourage investment activity, both local and foreign.

- Many Caribbean countries have rooted their macro-economic

stability in fixed exchange rates with open foreign exchange windows.

But fixed exchange rates have fallen out of favour around the world.

However, in T&T with the managed or dirty float the effect is virtually the same.

- As Porter states, and agreed by Sachs, the state has an important role to play since in small countries development is based on macro-stability and high quality infrastructure.