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Summary of Selected Issues on the Eastern Caribbean Currency Union (ECCU)

Core Content

This report, published by the International Monetary Fund (IMF) in June 2017, examines productivity and potential output in the Eastern Caribbean Currency Union (ECCU), as well as the fiscal rules that govern the region's public debt and deficit targets. The analysis is based on data up to May 2017 and aims to inform economic policy decisions.

Productivity and Potential Output in the ECCU

A. Historical Trends in Output and Factors of Production

• Output Growth: The ECCU has experienced slower growth compared to emerging markets and developing economies (EMDEs) over the past four decades, with an annualized growth rate of 3.3% since 1980.
• Growth Performance: There is significant variation in growth performance among ECCU countries. St. Kitts & Nevis and Antigua and Barbuda have had the highest GDP per capita, while Dominica and Grenada lagged.
• Population and Employment: Outward migration has reduced the population growth rate, with St. Lucia and Antigua and Barbuda experiencing the highest population growth due to lower emigration. Employment-to-population ratios vary widely, with some countries like St. Lucia having lower ratios.
• Human Capital: Educational attainment has improved, but the high proportion of skilled emigration has limited the growth of human capital.
• Impact of Natural Disasters (NDs): NDs have significantly affected physical capital accumulation, leading to higher depreciation and investment inefficiencies. Dominica, for example, suffered six major NDs between 1970 and 2015, each causing an average of 46% GDP damage.

B. Measuring Productivity Trends

• TFP and Growth Decomposition: Total Factor Productivity (TFP) has been a key driver of growth in the ECCU, but its contribution has declined over time, especially after the Global Financial Crisis (GFC).
• TFP Calculation: The report modifies the standard Cobb-Douglas production function to account for NDs by introducing an efficiency factor $\theta_t$ to reflect the impact of disasters on capital productivity.
• Labor Productivity: Labor productivity is low, with most labor concentrated in less productive sectors. The private sector's unit labor costs have increased significantly since the GFC, outpacing productivity growth.
• Sectoral Analysis: Financial intermediation, agriculture, and transport are the most productive sectors, but they account for only 15-25% of total employment. Public administration and hotels/Restaurants are among the least productive.

C. Implications for Potential Output

• Potential Output Growth: The report estimates potential output growth in the ECCU to be between 1.5% and 2.5% for the period 2016-21. A continuation of current trends would imply growth closer to the lower end of the range.
• Policy Recommendations: To improve potential output, the report suggests reforms that enhance factor mobility, including addressing skill mismatches and improving education and training. It also emphasizes the importance of labor market policies that influence migration and sectoral labor allocation.
• Investment and Infrastructure Resilience: Increasing investment and ensuring infrastructure resilience to natural disasters could help boost potential output. Additionally, public wage policies should be mindful of their broader economic impact, particularly on investment in other sectors.

Fiscal Rules for the ECCU

A. Limits of the Current Framework

• The ECCU has a public debt target of 60% of GDP and a deficit target of 3% of GDP, but these are not binding and lack short-term operational guidance.
• The debt target was extended from 2020 to 2030 due to non-compliance and economic challenges.
• The current framework does not include a mechanism for policy coordination among member countries.

B. The Increasing Use of Fiscal Rules

• Fiscal rules have become more common globally, with at least 45 economies implementing them by the early 2000s.
• These rules aim to rein in public debt, ensure fiscal discipline, and support sustainable economic growth.
• Examples include Grenada and Jamaica, which have implemented explicit fiscal rules to manage public debt and deficits.

Key Countries and Fiscal Rules

Grenada

• Governed by the 2015 Fiscal Responsibility Act.
• Targets an explicit primary surplus.
• Sets a wage bill at 9% of GDP.
• Limits real growth in primary spending to 2% annually.
• Sets a primary surplus at 3.5% of GDP.
• Has a debt anchor of 55% of GDP, estimated to be reached by 2021.
• Includes escape clauses for natural disasters, recessions, and financial crises.

Jamaica

• Governed by amendments to the Financial Administration and Audit Act and the Public Bodies Management and Accountability Act (2014).
• Sets a primary surplus consistent with lowering public debt to a set ceiling.
• Debt anchor is 60% of GDP, to be reached by end-March 2026.
• Annual deviations from the overall balance floor are stored in a notional account.
• Accumulated deviations of more than 1.5% of GDP trigger annual adjustments.
• Accumulated deviations of 3.5% of GDP force primary expenditures adjustments of 1.5% of GDP.
• Both adjustments require Parliament approval.

Conclusion

The report highlights that the decline in TFP and low labor productivity are major factors constraining growth in the ECCU. It underscores the need for policy reforms to improve factor mobility, enhance investment efficiency, and build resilience to natural disasters. Additionally, it emphasizes the importance of fiscal rules in achieving long-term fiscal stability and sustainable growth, particularly in the context of the ECCU's extended public debt target. The analysis serves as a basis for formulating future economic policies and potential growth scenarios.