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3. Constraints on economic development
The following section considers the basic economic constraints confronting the Pacific Island region. Most of these constraints have been identified in the consultancy reports provided in such prodigious quantities by the multilateral financial institutions and bilateral aid donors. These reports are in a sense homogeneous products with a rather uniform set of conclusions and recommendations. While many are clearly correct, others are regrettably misdirected. Such policy prescriptions are inappropriate for a region where the traditional recommendations of structural adjustment are virtually impossible because of the low level of economic development and multiplicity of development constraints.
3.1 Size of market and scale of operations
The limited size of the domestic market and supply of factor inputs reduces the availability of economies of scale and hence adversely affects the competitiveness of Pacific Island producers. In general, any product requiring large-volume production cannot be considered within this region so that island states must increasingly concentrate on small market niche products.
To overcome the small size of the domestic market, the Pacific Island countries could become part of a larger trading bloc.
[The 1975 SPEC Agreement , which established the precursor to the Forum Secretariat, had the specific intention of moving the Forum Island countries towards greater regional economic cooperation. The most significant movement in that direction has been the SPARTECA non-re ciprocal trade agreement. In 1992, the Melanesian Spearhead Group of PNG, Solomon Islands and Vanuatu signed the MSG Trade Agreement , a multilateral trade preference agreement that now extends to 150 product lines. Fiji has also recently begun offering commodity specific bilateral trade agreements to its neighbours, including Tuvalu, Tonga and Vanuatu.]
This has been recommended on a number of occasions, but the islands are reluctant to pursue this type of policy because the loss of sovereignty it entails is especially distasteful to nations that have only recently achieved independence. Many of the reports have recommended the formation of trading groups, but the views by no means have been homogeneous.
[See, for example, Hardin and Associates, Prospects for a Preferential Free Trade Agreement between Papua New Guinea, Solomon Islands and Vanuatu, part B s. 1.2; Pacific Island Economies, World Bank Report, 1995, ss. xxxvi, xxxviii, 6.4 and 6.5.]
However, the lack of a clear regional consciousness – even more so than in other parts of the world – renders a more regional perspective difficult. Furthermore, the large distances between the island countries and between the island countries and their main markets increase transport costs and hence reduce competitiveness. The effects of these distances on competitiveness can be minimised by establishing efficient, low cost shipping and aviation services. In this area there does seem to be advantages in regional cooperation. Increased competition in aviation could lead to lower air fares, with resultant gains in tourism. The European Union has been at the very forefront of assisting Pacific Island states to improve transportation infrastructure under Lomé II and III.
[The Pacific Forum Line could not have been established had it not been for lines of credit available from the European Investment Bank under the Lomé Convention.]
Smallness is inherently a problem when combined with isolation only if one seeks large-scale distant markets. The increased costs associated with this apparently fundamental and immutable characteristic of the Pacific ACPs means that large-scale exporting is simply impossible. The characteristics of isolation and diseconomies interact in a non-linear way. An example may be sufficient to explain some of the complexities involved: the distance between Suva and Tokyo is twice that between Honolulu and Tokyo, yet
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in 1994 air freight rates for cut flowers from Suva to Tokyo were four times as high as between Honolulu and Tokyo. In large measure, this was the direct result of the fact that at the time there was only one carrier with sufficient capacity to carry cargo and most of that space was being employed for chilled fish. Rates, since the entry of a new competitors, have begun to fall. A similar experience occurred in the case of Tonga when it began exporting squash to Japan. At first it paid P$260,000 per shipment. However, within a year or two, as exports increased and competition for shipments began to increase, the rate fell to P$ 100,000 per shipment. As a result, the cost of isolation was decreased.
Smallness is problematic also because the Pacific ACPs choose to operate within the context of the geopolitical legacy of the colonial powers. The Pacific ACPs are small when they act alone but there is absolutely no reason for this to be the case. Moreover, there are demonstrable economic benefits to greater regional co-operation. The example of a multilateral fisheries access treaty with the US, which provides returns of 10% of catch compared with the 2% that Pacific ACPs receive in bilateral agreements with Taiwan, is an example of how the Pacific ACPs can benefit from co-operation at a regional level. As small individual suppliers of tuna, however, the Pacific ACPs can expect to continue to receive low rates of return for the sale of their product.
3.2 Mobilisation of land resources
One of the most difficult and sensitive constraints facing Pacific ACPs has been the mobilisation of land resources in the development effort. In all Pacific ACPs the majority of land is traditionally owned, and only in one country – Fiji – has there developed an appropriate mechanism for intermediation between traditional land owners and developers. Fiji’s modus vivendi between investor and traditional landowner has permitted a degree of orderly lease of land and avoided the difficulties experienced by other Melanesian countries. Fiji is unique in the Pacific, having a relatively abundant land resource, unlike most of Polynesia, as well as a transparent, consistent and relatively reliable means of leasing some of that land, unlike much of Melanesia.
This depiction of Fiji’s land tenure system as conducive to investment and trade development is by no means static. There have been dramatic changes, and there is increasing evidence that large tracts of land will be returned to traditional owners when the principal legislation governing the lease of sugar cane land, the Agricultural Landlords and Tenants Act (ALTA), expires in 1997. Moreover, in the last few years, blockades of hotels in Fiji by traditional landowners have shaken the confidence of investors in the tourism sector in leasehold land. [In 1995, despite clear shortages of five-star hotel accommodation and the need to construct at least two or three such hotels, there was no investment. This situation was rectified only when the Government of Fiji introduced twenty-year tax holidays for new five-star hotels.]
In Melanesia, especially in PNG and to a lesser degree in Solomon Islands, the absence of clear delineation of land title has created a situation where land disputes have delayed or completely halted development contracts. This is compounded by a widespread perception among investors that traditional landowners in Melanesia are unwilling to fulfil the terms of various land contracts. This lack of faith in the force and the enforceability of contracts has impaired investment and, ultimately, export-oriented growth. [In view of the strong social and cultural implications of any change to the system of land ownership, this is not an easy problem to solve. Most recommendations have been muted and restricted to generalities, as in the World Bank Report (s. 2.71): … clarifying property rights and relaxing regulatory barri ers on foreign land use … are some of the measures that the PMC state could adopt to make the domestic economic environment more conducive to inward investment.]
3.3 Proneness to natural disaster and external shocks
The small Pacific Island states are especially vulnerable to external shocks of two types: [The World Bank Report (s. 2.18 and s. 2.22) develops this point.]
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- Natural disasters. For example, in years with a cyclone, export earnings fell sharply, in Fiji in 1980 (31% fall), Vanuatu in 1985 (42% fall), Western Samoa in 1991 (39% fall). The data above do not fully measure the impact of natural disasters. Western Samoa has been utterly devastated not only by the impact of cyclones Ofa and Val in the early 1990s, which devastated the export sector, but by the effects of taro blight in 1993, which wiped out the country’s food staple and remaining agricultural export. As a result of natural disaster, the import to export ratio in Western Samoa has gone from an average of 3:1 to 14:1 in 1993.
- Terms of trade shocks. A recent example of this has been the growth and sudden decline in Fiji garment industry exports to New Zealand. In 1987 exports were F$ 312,792, rising to F$ 54.6 million in 1989 and F$ 50.7 million in 1990 before falling to F$ 19 million in 1993. In large part, the loss of the New Zealand market is attributable to the decline in margins of trade preference resulting from the unilateral trade liberalisation, along with the simultaneous revision of the New Zealand Income Tax Act, which included all income derived from the tax-free garment factories in Fiji as income in New Zealand.
3.4 Law and order
One of the most serious structural constraints to development in PNG and increasingly in Fiji is the perceived deterioration in law and order. The economic effect of this has been a rise in operating costs and decrease in relative competitiveness of those Pacific ACPs confronting such problems. The cost increases come not only from the direct costs associated with increased security, but also, and possibly more importantly, from the increased risk premium that mobile skilled labour and management put on working in such countries. This results in increases in the amount of net emigration of such skilled labour and management and limits the willingness of individual local small investors to invest.
3.5 Poor skill development and relatively low levels of educational attainment
Literacy rates in the region, especially in Melanesia, are low and in general there is an inadequate supply of skilled labour.
[In PNG, the estimated 1990 literacy rate is 22%. In Vanuatu, the literacy rate is estimated to be 30% and in Solomon Islands the rate of effective literacy is between 15 and 20%. If these literacy rates seem disturbingly low, it must be remembered that the first Papua New Guinea national to receive a university degree did so only in 1968, just seven years prior to independence.]
In many of the countries of the region, skilled tradesmen need to be imported even for medium-sized construction projects. Only Fiji and, to a lesser degree, Tonga possess a pool of skilled labour and management that is capable of shifting from product to product and sector to sector.
In fact, the absence of a pool of skilled labour and management is the greatest single constraint to the development of the region. The reason is that in most export industries unskilled labour is simply not a large enough component of total cost to offset efforts to change wages to overcome the cost disadvantage of having to use imported manpower (which is paid not only an international market wage but often also a hardship or risk premium to induce labour to work in Pacific ACPs).
One study found that a model Fiji garment factory would be unprofitable, given the cost structure, in all twelve other Forum Island countries. [See R. Grynberg and M. Powell, Taxation in the Island Nations of the South Pacific , Vol. I, pp. 85-90.] Skilled labour was such a large proportion of total cost and was so much more expensive than in Fiji that the project was not viable. Even with unskilled wages set at zero, the project was viable only in Solomon Islands, which has the most competitive nominal wages in the region. While the study managed to compare nominal price and wages in Pacific ACPs, there was no attempt to study productivity levels which are demonstrably lower than in many competing countries in Asia. This is in large measure because of the absence of any serious research on productivity in the Pacific ACP region, despite the continual claims that it consti-
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tutes a serious constraint to development. The importance of the conclusion is that if, even with zero wages, the most basic labour-intensive export industries such as garment manufacturing would prove unprofitable, then the calls to lower real wages in order to stimulate exports from the region may prove futile until such time as the skills exist to assure that export supply elasticities are significantly greater than zero. [There have been calls for decreases in wages in PNG ever since the 1992 Minimum Wage Board ruling that decoupled wages from the CPI. This argument is the main theme of Fallon, et al., Exchange Rate Policy in Papua New Guinea . It is echoed by A. Elek in his review of Fallon, et al. (see Pacific Economic Bulletin 10(1): 145-50).]
These low levels of productivity observable in the Pacific ACPs are in large measure a product of this stage of development. As education levels rise and as experience is gained in the modern context, productivity will almost certainly rise. However, little can be done very quickly that will result in the attainment of productivity levels comparable to those currently observed in Asia. It is one of the areas on which Pacific ACP governments must place great emphasis, as orthodox economic policies will not prove successful until a pool of skilled labour is developed.
3.6 Constraints imposed by the impact of macroeconomic policy
a) Currency
Many of the problems of economic development confronting the region are neither externally imposed nor the result of the nature and location of the region. The state of the macroeconomic environment has been a continual source of discussion by economists from the development banks. There is good reason for this. They understand exchange rates. The complexity of the microeconomic structural and cultural problems of countries is a problem not dealt with easily by anyone, and not even the passage of time necessarily resolves these difficulties easily. Thus while the multilateral development banks always pay lip service to the structural issues, it is the macroeconomic issues upon which they focus.*
- *[The World Bank Report considered that (s. 2.60):
A three pronged strategy is required to enhance competitiveness... . This will require
– the maintenance of a macroeconomic environment that meets the twin goals of price stability and competitive pricing of … resources
– a reduction in the anti-export bias of trade policy and tax regimes
– reducing barriers to domestic and foreign direct investment.]
- *[AIDAB ‘Papua New Guinea: The Role of Government in Economic Development’ , p. 5; J. Fallon, et al., Exchange Rate Policy in Papua New Guinea . In the case of Fiji, the World Bank’s most recent analysis came very close to recommending a currency devaluation in order to retain competitiveness (p. iv):
Adding to these (competitive) pressures is the appreciation of Fiji’s real effective exchange rate by 12% between 1990 and 1994. While acknowledging the important anti-infla tionary role of the nominal peg, the Government should also recognise that the exchange rate remains the single most potent instrument for influencing the overall competitiveness of the economy and for stimulating potential trade opportunities.
It seems to be widely accepted that the Fiji dollar is overvalued (see Coultas et al., p. 43; Thompson Pacific, Fiji Exports to New Zealand , s. 6.8).]
b) Labour market
To the extent that Pacific Island governments’ policies fail to restrain wage rises, competitiveness will fall, causing a reduction in opportunities for trade. The Price Waterhouse report, Traded Services in the Forum Countries, concluded (s. 2.4):
Thus, greater labour market flexibility may be necessary in relatively high cost destinations such as Vanuatu, Fiji, Tonga and PNG.
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The report also noted that some limited progress had already been made in this direction (s. 3.14):
In Fiji and PNG there have been moves towards enterprise based negotiations on wages and productivity growth has become a factor in determining wage rises. These are useful moves towards freeing up the labour market which should contribute to more efficient employment and use of labour.
c) Taxation system
In the Pacific ACP states there has been a very high dependence upon import duties and this has rendered the countries inefficient in the past. Many of the reports recommend reform, though this has been a remedy rarely accepted.
The World Bank Report (s. 2.64 and s. 2.66) argues:
While providing a steady stream of revenue, high import duties raise the cost of doing business in the PMCs and discourage exports. In terms of providing protection for domestic producers, high import duties are counter-productive. Remoteness from major markets already provides the PMCs with a high degree of natural trade protection …
While high tariffs convey a measure of protection to domestic producers, opportunities for import substitution are quickly exhausted because of small populations and low incomes.
The obvious response is to cut taxes on imports, but this raises the question of alternative sources of government revenue. The World Bank Report favours a switch to a value-added or consumption tax (s. 2.66):
Through well managed macroeconomic policies the Pacific Island governments can help improve the efficiency of domestic producers and hence encourage trade and investment. However these measures will count for nought if in practice the will to invest is frustrated by complex bureaucratic procedures.
d) Loss of trade preference
The Pacific ACP states that have successfully managed to export in large volumes have frequently done so with the assistance of trade preference under the terms of the Lomé Convention, the SPARTECA treaty and the GSP. The closure of the Uruguay Round and liberalisation of external tariffs has meant that the margin of trade preference that had been available to Pacific ACP states has been eroded in their traditional markets. This has decreased the value of these preferential trade agreements.
The World Bank Report has clearly stated that Pacific ACP states will lose trade preference directly as a result of the closure of the Uruguay Round (s. 2.43, p. 20):
Practically all the Pacific Island states’ present and potential exports will suffer from some measure of preference erosion as a result of GATT-agreed tariff reduction… But how important will this be to the short and medium term trade performance in Pacific Island states? The answer to this is probably very little in the short run, but potentially much more so over 5 or 10 years unless Pacific Island states adjust to a more competitive global marketplace.
The 1995 ESCAP report has been more explicit in its assessment of the impact of the Uruguay Round. The ESCAP Report states (p. 13):
Prior to its establishment, the Director General of GATT emphatically stated that the successful conclusion of the Uruguay Round meant more investment, more jobs and larger income growth for all … However, as the details of the package negotiated in the Uruguay Round are unraveled a less euphoric interpretation is emerging. Many analysts believe that the benefits from the new deal will be unevenly distributed. Sub-Saharan Africa, the Caribbean and small Pacific Island economies may in fact stand to lose overall despite elaborate provisions for special and differential treatment for developing countries and more favourable treatment for
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least developed countries and net food importers.
Effects of the closure of the Uruguay Round will include:
- increases in the prices of imported food;
- decreases in sugar prices for Fiji exports;
- increased competition in garment exports; and
- decreased margins of trade preference for tropical tree crop products into the EU market.
© Friedrich Ebert Stiftung | technical support | net edition fes-library | November 2001
