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CHAPTER 4: The Macroeconomic Impact of Trade Preference Erosion on the Caribbean

Author(s):
Sanjaya Panth, Paul Cashin, and W. Bauer
Published Date:
October 2008
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Author(s)
Montfort Mlachila, Paul Cashin and Judith Gold 

A. Introduction1

The banana and sugar industries of the Caribbean have enjoyed significant trade preferences for several decades. Preferential access to protected European markets has afforded Africa, Caribbean, and Pacific (ACP) producers higher export prices than otherwise, and thus provided them with implicit income transfers. Reforms to the European Union’s banana and sugar regimes over the last 15 years have eroded those preferences, and recent reforms will further reduce the implicit income transfers. The erosion of trade preferences has important economic and social effects, given the dependence of Caribbean countries on the production and export of these traditional export crops.

The countries of the Caribbean are among the most vulnerable to terms of trade losses arising from trade preference erosion. This vulnerability arises from a large share of bananas and sugar in total exports, the very high degree of preferential access granted by the European Union, and the region’s heavy dependence on the European Union as an export market.

This chapter complements previous studies by considering the macroeconomic effects of the erosion of EU preferences for Caribbean banana- and sugar-producing countries.2 As a first step, the analysis measures the value of (banana and sugar) trade preferences, illustrating its precipitous decline since the early 1990s. Second, the chapter discusses the macroeconomic impact of the cuts in implicit assistance, particularly on output growth in preference-dependent Caribbean countries.

The remainder of this chapter is structured as follows. Section B briefly reviews the recent institutional and market changes in EU preference schemes for bananas and sugar. Section C examines the results of studies that have attempted to measure the impact of preference erosion on the Caribbean. Section D sets out the movement of export prices, volumes and receipts for banana- and sugar-exporting Caribbean countries, while Section E estimates the value of implicit assistance provided through trade preferences. Section F illustrates the macroeconomic impact of preference erosion, while Section G examines policy implications and trade preference erosion in the work of the Fund. Section H concludes.3

B. Caribbean Traditional Industries: Description and Historical Overview

Banana industry

The export banana industry of many Caribbean countries was established after the Second World War, in order to supply the United Kingdom market and replace unprofitable sugar production in the Caribbean. While at its peak in the early 1990s the banana industry comprised about 20 percent of (Windward Islands and Belize) GDP, it has declined to less than 5 percent of GDP in recent years.4 Even so, banana exports remain important—for example, accounting at present for about 15 percent of merchandise export receipts and remaining a key employment source in the rural districts of most of the Windward Islands.5 Banana production in the Windward Islands and Belize is entirely in private hands, with the government providing some financial and other support to producers. In contrast, banana production in Suriname has traditionally been a public sector activity.

Production yields are significantly lower in the Caribbean when compared with Latin American banana producers. Banana farms in most Caribbean countries are typically less than 10 acres in size, and are often located in difficult terrain (steep hillsides and narrow valleys). The combination of less favorable topography, climate, and labor conditions results in low yields per acre and relatively high production costs (NERA, 2004).6

For four decades prior to 1993, ACP producers enjoyed preferential access as traditional suppliers to the United Kingdom market. Prior to 1993, individual EU members maintained distinct policies for banana imports, including preferential regimes for member states’ overseas departments or former colonies (e.g., France imported from Martinique and Guadeloupe, Cameroon and Côte d’Ivoire, while the United Kingdom imported from the Windward Islands and other ACP countries).7 Historically, ACP bananas were exported to the United Kingdom under preferential agreements codified in the banana protocol of the various Lomé Conventions (cooperation agreements between the then European Community and ACP countries, which commenced in 1975 and expired in 2000).

The European Union’s preferential regime for bananas has undergone significant change over the last 15 years. Along with the implementation of the EU Single Market in 1993 came a common policy and marketing structure for banana imports. Under the so-called EU Banana Regime, preferential arrangements for ACP bananas were extended under a new import regime that encompassed the entire European Community (Dickson, 1993).

ACP producers were granted a duty-free quota that was allocated to each country on an historical basis. The post-1993 EU-wide system, however, eliminated internal trade barriers to allow the free circulation of ACP bananas, exposing high-cost Caribbean producers to more competition. The most severe blow for Caribbean producers came in 1998, when country-specific ACP quotas were removed. This allowed more efficient African countries to compete directly with less efficient Caribbean producers to fill the ACP quota. As a result, Cameroon and Ivory Coast banana exports to the European Union experienced strong growth, while those of the Windward Islands declined.

The EU banana regime operated on the basis of an annual ACP banana quota for duty-free export to the European Union, and an annual quota for bananas from Latin America (“dollar” bananas) subject to a tariff. The importation of bananas into the European Union also required a license, and the licensing system allowed the banana-exporting countries the possibility of sharing in the associated economic rents (Williams and Darius, 1998). As a result, the price of bananas in the European Union averaged some 80 percent more than the world (free market) price (Figure 4.1).8 Following World Trade Organization (WTO) rulings that the European Union’s banana import regime discriminated against Latin American exporters, in late 2001 the European Union pledged to switch to a tariff-only system by the beginning of 2006, and requested a WTO waiver authorizing tariff preferences for ACP countries under the Cotonou Agreement (successor agreement to the Lomé Conventions) until 2007. Under this compromise, the European Union agreed that the waiver would apply only if the new tariff is set at a level that maintains total market access for all WTO member suppliers, including non-ACP countries.

Figure 4.1.Real Banana Prices, January 1997–April 2007

(U.S. dollars per metric ton)

Sources: International Monetary Fund, Commodity Price System; and World Bank.

Notes: Banana (world) Central American and Ecuador, is the U.S., importer’s price, f.o.b. U.S. ports; banana (European Union) is the import price, c.i.f. European ports. Dashed lines are measures of the long-run trend (smoothed versions) of the respective real price series. All nominal price series were deflated using the export unit value index of industrial countries.

Recent reforms to the EU banana regime (moving from quotas to a tariff-only system) will further erode preferences for Caribbean banana producers. Beginning January 1, 2006, the European Union moved to a tariff-only regime (no quotas or licenses) with a permanent MFN (most favored nation) tariff of €176 per ton for Latin American bananas, and a duty-free 0.775 million-ton quota for ACP countries.9 The appropriate (quota-equivalent) level of this tariff remains in dispute, and has been challenged by Latin American exporters and the United States.10 While the conversion of quotas into tariffs will afford some protection to ACP banana-exporting countries, Caribbean banana exporters are likely to face strong competition from more efficient African and Latin American producers.

The European Commission has developed assistance plans to support the adjustment of ACP countries to the reformed banana regime. Assistance from the European Commission to Caribbean banana-exporting countries is being provided through (i) the Special Framework of Assistance (1999–2008), which was designed to boost the productivity of producers, encourage diversification (away from agriculture), and provide social protection;11 and (ii) export revenue stabilization schemes, such as STABEX. Under the Special Framework of Assistance (SFA), since 1999 the European Union has committed €157 million for adjustment assistance to the Windward Islands and €22 million to Belize. However, the disbursement of SFA resources to Caribbean countries has been extremely slow, with the bulk of committed amounts remaining undisbursed and virtually no disbursements since 2003 (Figure 4.2).

Figure 4.2.Caribbean: Status of EU Banana Support 1

(In millions of Euros)

Sources: Delegation of the European Commission, Barbados; and the Government of Belize.

1 Under Special Framework of Assistance, as at 31 March 2007.

Sugar industry

Under the Lomé Convention (and now the Cotonou Agreement), trade preferences for sugar have been granted to ACP countries by the European Union since 1975. EU internal sugar prices are maintained at three to four times the world price through production quotas, import tariffs and export subsidies (Figure 4.3). Under the Sugar Protocol ACP countries export 1.3 million tons of sugar duty-free at EU internal prices, with limited additional access (at preferential tariff rates) under a special preferential sugar (SPS) quota. The preferences are given by way of individual country quotas at prices similar to those received by domestic producers.

Figure 4.3.Real Sugar Prices, January 1990–April 2007

(U.S. cents per pound)

Source: International Monetary Fund, Commodity Price System.

Notes: Sugar (United States) is the U.S. import price, CSCE nearest futures, c.i.f. New York; sugar (European Union) is the European Union negotiated import price for raw unpacked sugar from ACP countries, c.i.f. European ports; sugar (world) is the free market price, CSCE nearest futures, c.i.f. New York. Dashed lines are measures of the long-run trend (smoothed versions) of the respective real price series. All nominal price series were deflated using the export unit value index of industrial countries.

As a result of moves to reform the Common Agricultural Policy, in November 2005 EU agriculture ministers agreed to a four-year, 36 percent phased price reduction. The import price will be lowered from €523 per ton to €335 per ton by 2009 for raw sugar imported from ACP countries, based on cuts of 5 percent in 2006, 13 percent in 2008, and 22 percent in 2009.12 SPS quotas would be eliminated. Sugar imports under the Everything But Arms (EBA) initiative will expand until 2009, when they will cease to be restricted. EU farmers would be compensated for about two-thirds of lost revenue. The proposed reform would imply significant adjustment costs for ACP countries that now enjoy preferential access to the EU market. Of the six sugar-exporting Caribbean ACP countries—Barbados, Belize, Guyana, Jamaica, St. Kitts and Nevis, and Trinidad and Tobago—Belize and Guyana will be the most significantly affected.13

The EU Commission is developing an assistance plan to support the adjustment process of ACP sugar-exporting countries. The assistance packages are to be tailored to country-specific development needs based on Adaptation Strategies as set out in National Action Plans, which were submitted to the European Union in April 2006. The plans provide estimates of implementation costs, as a basis for determining the per-country assistance needs under the European Union’s financial framework for 2007–13. The intention is to strengthen the competitiveness of sugar sectors where these sectors are considered to be economically viable, and promote diversification where the sector is not sustainable.14 The Caribbean response has been varied, with envisaged measures ranging from increasing production and enhancing added value to the mitigation of adverse social impacts of the downsizing or closure of the industry. Following an initial amount of €40 million in assistance for 2006, the European Union will provide funding of €667 million for the period 2007–10, with an initial allocation of €165 million for 2007. The amounts for 2011–13 are yet to be decided.15

C. Preference Erosion and the Caribbean16

Preference erosion can occur through a number of channels. Erosion can occur when the number of beneficiaries entitled to preferential trade treatment rises, or when a preference-granting country lowers its applied tariff while keeping its preferential tariffs unchanged, or (as in the case of the European Union’s banana and sugar markets) when a preference-granting country lowers its preferential tariffs (National Economic Research Associates, 2004).

Virtually all studies on the effects of international trade liberalization—notably by reducing preferential trading arrangements—agree that it is globally welfare enhancing. The theoretical case for removing trade preferences can be made easily. Granting trade preferences allows the development of trade that would not exist, usually at the expense of third countries. A country that receives trade preferences enables its exporters to charge a higher price than they would receive if they were selling to a nonpreferential market. While the extra production benefits the exporting country, there is an opportunity cost—the resources used in production could be used more productively elsewhere, especially if the country is an inefficient producer. For the country granting preferences, there is likely to be an increase in domestic prices owing to the entrance on the market of inefficient producers. For third countries, exclusion from trade preferences leads to a loss in competitiveness and therefore to lower production—this in turn can reduce its imports, leading to an overall decline in global trade (Baldwin and Murray, 1977; Stoeckel and Borrell, 2001).

There is widespread agreement that losses from preference erosion are likely to be concentrated in a few countries and products. Two recent analyses of the potential effects on middle-income and low-income countries of reduction in preferences in the United States, the EU, Canada, and Japan, find that the negative impact is concentrated in less than ten countries, and about six products.17Alexandraki and Lankes (2004) demonstrate that the aggregate loss is quite small, between 0.5 and 1.2 percent of total exports of middle-income countries. However, they also show that the loss is concentrated in just three products where preference margins are high: sugar, bananas—and to a far lesser extent—textiles and clothing. Countries with the greatest export losses arising from preference erosion are Mauritius, St. Lucia, and Belize, with Dominica and St. Vincent and the Grenadines also among the 10 most-affected countries (Table 4.1).18Subramanian (2003) finds that preference erosion would lead to a reduction of just 1.7 percent in the aggregate value of low-income country exports. While the losses are large in absolute terms only for a few countries such as Bangladesh, Cambodia, Mauritania, and Malawi, a number of others suffer sizable losses relative to exports.

Table 4.1.Contribution of Major Export Products to Preference Margin
Percent of margin accounted for by preferences for:
Total preference margin 1SugarBananasTextiles and clothingOther products
Mauritius39.9840133
St. Lucia32.909414
Belize29.34723030
St. Kitts and Nevis28.794006
Guyana24.295014
Fiji24.196012
Dominica15.909703
Seychelles12.2000100
Jamaica9.7678718
St. Vincent and the Grenadines9.4089011
Albania8.9004852
Swaziland8.297012
Serbia and Montenegro7.62871056
Honduras6.75691915
Tunisia5.9017920
Côte d’Ivoire5.7851238
Morocco5.7046433
Dominican Republic5.523162734
Middle-Income countries24.942191227
Largest beneficiaries315.65124817
Source: Alexandraki and Lankes (2004).Note: Caribbean countries are in bold.

As a percent of the trade-weighted average world market price of the country’s exports.

Average for 76 middle-income developing countries, weighted by margin.

Eighteen countries with average preference margins greater than 5 percent.

Source: Alexandraki and Lankes (2004).Note: Caribbean countries are in bold.

As a percent of the trade-weighted average world market price of the country’s exports.

Average for 76 middle-income developing countries, weighted by margin.

Eighteen countries with average preference margins greater than 5 percent.

Banana-exporting countries

The erosion of trade preferences over the last two decades has already had a significant impact on Caribbean banana producers. During the 1990s exports from the Windward Islands, Belize and Suriname fell dramatically, driven by competition from African ACP countries, uncertainty as to the status of the banana regime, and the rise of the services sector. Employment declines were ameliorated by banana growers working on a part-time basis, taking early retirement, seeking employment in other industries, or emigration. The Windward Islands in particular have been successful in diversifying into tourism and financial services, which have more than offset the decline in banana export earnings.

Most existing estimates show that the loss from trade preference erosion for Caribbean banana-exporting countries will be large. On the basis of an EU tariff level close to the current €176 per ton and individual country supply elasticities, NERA (2004) finds that banana production in the Windward Islands countries would decline by between 11–21 percent from its end-2005 level.

In a comprehensive review of the literature on banana preference erosion, the FAO (2004) makes a number of interesting observations. Contrary to most studies—which typically make ad hoc assumptions on the level of tariff reductions19—the studies cited in FAO (2004) are more realistic as they typically measure the effects of moving to a tariff-only regime in 2006, and modify tariff levels and supply elasticities. A key finding is that there is no tariff that would maintain the status quo—in terms of providing the same level of implicit assistance—a central objective among ACP countries, especially in the Caribbean. In particular, a low tariff would undoubtedly benefit Latin American suppliers and adversely affect EU domestic and ACP suppliers, and vice versa.

Sugar-exporting countries

The few studies on the implication of sugar preference erosion generally concur that the majority of Caribbean sugar industries have very little prospect of survival. The protected markets in the European Union have afforded higher prices to Caribbean commodity exporters than they would have obtained on the free market, on average over 250 percent higher than the world prices in the past 15 years. This preferential trade contributes significantly to the Caribbean region’s employment, export receipts and output. Nevertheless, even with this price advantage, the majority of the sugar industries in the region have not been profitable for many years. As a result, a recent study concluded that other than the sugar industries in Belize and Guyana, all other industries in the Caribbean appear to have an unprofitable future following preference erosion, leading to their probable eventual closure (LMC International, 2003). While the sugar industries in Belize and Guyana have the potential to remain profitable, they will need to undertake significant reforms, including the closure of marginal estates and sizable new investment to upgrade plants and develop value added.

Virtually no studies exist that document both the value of implicit assistance from trade preferences and its evolution over a long period. Almost all the studies reviewed here take a snapshot of the state of affairs for one year or just a few years. However, in order to understand how countries arrived at their present situation, it is useful to measure the value of preferences over time. The following sections do so for Caribbean countries over a period of almost three decades.

D. Evolution of Export Prices, Quantities, and Values

Banana-exporting countries

Real banana export prices have exhibited a secular downward trend over the past three decades. United Kingdom real banana prices generally remained steady through the early 1990s and declined thereafter, until a sharp, weather-related uptick in prices in 2005 (Figure 4.4). An important influence was the decision to partially liberalize the European market from 1993, which increased competition and dampened prices. International (free market) prices also show a steady downward trend, with occasional peaks during the late 1980s and early 2000s—the latter resulting from weather-induced shortages.

Figure 4.4.Evolution of Real Banana Prices

(In 2000 U.S. dollars per metric ton)

Sources: IMF, World Economic Outlook; World Bank; WIBDECO; U.S. Department of Agriculture; and Fund staff estimates.

The evolution of banana export volumes from the Caribbean over the past three decades displays a bell shape. However, there are notable differences between the Windward Islands and Belize and Suriname. For the Windward Islands, volumes rose steadily between 1977 and the early 1990s, and declined thereafter, with the total volume exported in 2005 about half that of 1977 (Figure 4.5). The exception to this trend is Grenada, where exports were always small and the country largely ceased to export any meaningful quantities after 1996. Belize is the only country that did not suffer significant declines in export volumes during the period 1990–2005, becoming the largest Caribbean exporter by end-2005. For Suriname, export volumes rose very slowly in the 1990s. However, owing mainly to mismanagement the industry collapsed in 2002, only to recover in 2004.

Figure 4.5.Caribbean: Banana Export Volumes

(In thousands of metric tons)

Sources: Country authorities; WIBDECO; and Fund staff estimates.

The evolution of export values also has a bell shape. Total Windward Islands banana export receipts peaked at over 20 percent of GDP in 1989, fell dramatically after 1993, and declined to about 5 percent of GDP in 2005 (Figure 4.6). Banana exports have been particularly important for Dominica, St. Lucia, and St. Vincent and the Grenadines, accounting for about 40–70 percent of total merchandise exports, depending on the period. For Belize, export values rose substantially between 1990–2005, mainly reflecting the increased volumes noted above while unit prices generally declined. For Suriname, export values generally rose during the period, peaking in 2000, before collapsing in 2002.

Figure 4.6.Caribbean: Banana Export Earnings

(In millions of U.S. dollars)

Sources: Country authorities; WIBDECO; and Fund staff estimates.

Sugar-exporting countries

Real sugar export prices have also trended downwards in recent years. European sugar prices experienced a steady decline until 2001, yet have subsequently recovered (Figure 4.7).

Figure 4.7.Evolution of Real Sugar Prices

(In 2000 U.S. cents per pound)

Source: IMF, Commodity Price System.

Caribbean sugar export volumes were roughly constant over the previous decade, with a sharp decline in 2005. While export production peaked at over 700,000 metric tons in 2003, the contributions from Guyana and Belize have fallen in recent years (Figure 4.8). Exports from Barbados and Jamaica were largely unchanged over the 1995–2005 period, while those of St. Kitts and Nevis and Trinidad and Tobago were halved.

Figure 4.8.Caribbean: Sugar Export Volumes

(In thousands of metric tons)

Source: Food and Agriculture Organization.

Export values peaked in 1997, earlier than export volumes. While sugar exports have remained particularly important for Guyana and Belize, they have drastically diminished in importance for St. Kitts and Nevis, Barbados, and Trinidad and Tobago (Figure 4.9).

Figure 4.9.Caribbean: Sugar Export Values

(In millions of U.S. dollars)

Source: United Nations, COMTRADE.

E. Implicit Assistance from Trade Preferences20

The additional export revenue that Caribbean producers derive from preferential access to the European market represents an implicit income transfer. The amount of this implicit transfer can be calculated using a price-gap methodology—that is, the difference between the preferential European market price (for each of bananas and sugar) and the best price that could be obtained on unrestricted markets (the international market price). Expressing relevant market prices in free-on-board (f.o.b.) terms and scaling the price gap by the actual export volume (in metric tons) provides a measure of the value of this implicit transfer for each of bananas and sugar.21 In line with Alexandraki and Lankes (2004), we define the preference margin (m) for a given product as the proportion by which the average unit price received by a preference recipient j exceeds that received by an MFN exporter (world price):

where Pj and PW are the price received by country j and the world price, respectively. The implicit value of preferences for each producer j at time t is simply the product of the difference in prices and the quantity exported Qjt:

Several assumptions underly this computation. First, that there is no product differentiation in terms of quality, size, and origin. Second, a perfectly competitive price is assumed. Finally, all preferential rents accrue to exporters.22 To the extent that some of these assumptions are not verified in practice, then the computed value of preferences is likely to be somewhat exaggerated. However, this price gap method is considered by the World Trade Organization as the most transparent and objective (Sanchez, 2004).

Implicit assistance

Implicit assistance to banana exporters is calculated according to the formulation presented above (in Equation (2)). A complication is the prices used in the computation. There are two sets of banana prices that can be used. In the first approach, we use the wedge between United Kingdom wholesale prices for Caribbean ACP banana exports and the international (United States) landed prices for “dollar” banana exports. The second approach uses unit export prices for Caribbean ACP banana exporters and compares them with unit export prices for Latin American “dollar” exporters. Both approaches have advantages and disadvantages:

  • The first approach has the merit of data availability and transparency. The data for this approach are available throughout the period under study (1977–2005). However, this approach will represent the upper bound to the true amount of implicit assistance received by banana-exporting countries, as it assumes that the full margin between the European Union and international (free market) prices accrues to exporters.23
  • The second approach is probably closer to the lower bound of the true value of implicit assistance, as the price used is the f.o.b. price at the point of export. One drawback is that data are not available for all countries for the full period.

Regardless of the measure used, the level of implicit assistance delivered through EU trade preferences to banana exporters has been considerable (Table 4.2). Three stylized facts emerge from an analysis of the preference calculations (here measured using the first approach).

Table 4.2.Implicit Assistance from EU Banana Preferences, 1995–2005(In millions of U.S. dollars)
19951996199719981999200020012002200320042005Avg.
(Calculations based on European wholesale and U.S. landed prices)
Belize16.821.623.926.126.818.89.39.731.129.243.823.4
In percent of total export of goods and services5.67.07.28.06.44.32.22.16.35.88.05.7
In percent of GDP2.63.84.23.83.72.31.01.13.03.04.43.0
Dominica13.615.015.514.413.07.93.43.94.34.76.49.3
In percent of total export of goods and services12.212.311.39.58.35.52.83.23.63.64.67.0
In percent of GDP6.26.46.45.64.92.91.31.61.71.72.33.7
Grenada1.90.70.00.00.30.20.10.10.20.10.00.3
In percent of total export of goods and services1.50.50.00.00.10.10.10.10.10.10.00.2
In percent of GDP0.70.20.00.00.10.10.00.00.00.00.00.1
St. Lucia43.639.831.837.531.120.46.611.214.115.518.024.5
In percent of total export of goods and services11.511.38.99.68.55.31.93.53.63.33.66.4
In percent of GDP7.97.05.55.94.63.01.01.62.02.02.23.9
St. Vincent and the Grenadines21.016.713.820.517.812.25.97.79.48.310.413.1
In percent of total export of goods and services15.411.29.413.010.16.93.44.35.44.75.58.1
In percent of GDP7.95.94.76.45.43.61.72.12.52.12.44.1
Suriname15.49.014.712.215.710.35.71.10.07.822.410.4
In percent of total export of goods and services2.81.42.22.12.81.71.10.20.00.82.01.6
In percent of GDP2.21.01.61.11.81.20.70.10.00.71.71.1
(Calculations based on fob unit export values)
Belize2.62.31.111.614.416.48.05.46.35.95.07.2
In percent of total export of goods and services0.90.70.33.53.53.71.91.21.31.20.91.7
In percent of GDP0.40.40.21.72.02.00.90.60.60.60.50.9
Dominica7.45.05.05.87.55.02.32.72.73.42.54.5
In percent of total export of goods and services6.64.13.73.84.83.41.92.22.32.71.83.4
In percent of GDP3.42.12.12.32.81.80.91.11.01.30.91.8
Grenada0.60.10.00.00.00.10.00.00.00.00.00.1
In percent of total export of goods and services0.50.10.00.00.00.00.00.00.00.00.00.1
In percent of GDP0.20.00.00.00.00.00.00.00.00.00.00.0
St. Lucia17.416.210.713.416.214.05.68.77.19.27.211.4
In percent of total export of goods and services4.64.63.03.44.43.61.72.71.81.91.43.0
In percent of GDP3.22.81.82.12.42.00.81.31.01.20.91.8
St. Vincent and the Grenadines8.26.74.59.49.78.44.05.42.73.14.16.0
In percent of total export of goods and services6.04.53.16.05.54.72.33.02.22.62.23.8
In percent of GDP3.12.41.52.92.92.51.11.51.01.11.01.9
Suriname0.710.714.610.312.715.9-1.9-0.30.0-0.42.75.9
In percent of total export of goods and services0.12.13.02.43.03.2-0.4-0.10.00.00.21.2
In percent of GDP0.11.21.60.91.41.8-0.20.00.00.00.20.6
Memorandum items:
Average banana unit values for EU exports (U.S. dollars per tonne)466437443483506449423441436441508458
Free market (fob) unit value (U.S. dollars per tonne) 1275280310286266242260266263251261269
EU export unit values (as a percent of free market prices)170156143169190185163166166176195171
Sources: Country authorities; IMF, World Economic Outlook; U.S. Department of Agriculture; and Fund staff estimates.

Based on Ecuador bananas exported to the United States.

Sources: Country authorities; IMF, World Economic Outlook; U.S. Department of Agriculture; and Fund staff estimates.

Based on Ecuador bananas exported to the United States.

  • First, the value of implicit assistance has been quite high for all Windward Island countries (except Grenada), averaging about 8 percent of GDP for the period 1977–2005. In contrast, implicit assistance to Belize and Suriname was much lower, averaging less than 3 percent of GDP.
  • Second, the pattern of implicit assistance follows the same bell-shape as the evolution of export volumes, peaking in the late-1980s and early-1990s, and declining to levels below those observed at the beginning of the period by 2005 (Figures 4.10 and 4.11).
  • Finally, the level of implicit assistance for the Windward Islands has generally been higher than that of official development assistance (ODA) (Figure 4.14) and lower than ODA for Belize and Suriname. For example, preference-based implicit assistance received by St. Lucia over the past three decades is about double that received as ODA. In addition, ODA flows to Caribbean banana-exporting countries have fallen over time (Figure 4.15).

Figure 4.10.Caribbean: Implicit Assistance Derived from EU Banana Trade Preferences

(In percent of GDP)

Source: Fund staff calculations.

Figure 4.11.Caribbean: Implicit Assistance Derived from EU Banana Trade Preferences

(In millions of U.S. dollars)

Source: Fund staff calculations.

Figure 4.12.Caribbean: Implicit Assistance Derived from EU Sugar Trade Preferences

(In percent of GDP)

Source: Fund staff calculations.

Figure 4.13.Caribbean: Implicit Assistance Derived from EU Sugar Trade Preferences

(In millions of U. S. dollars)

Source: Fund staff calculations.

Figure 4.14.Caribbean: Nominal External Assistance (Official and Implicit)

(In percent of GDP)

Sources: Country authorities, OECD; and Fund staff calculations.

Note: Official Development Assistance (ODA) as defined by the OECD includes: grants, net concessional loans (including amortization payments), and technical cooperation from official agencies (including state and local governments, or by their executive agencies).

Figure 4.15.Caribbean Banana Producers: Official Development Assistance (ODA), 1975–2005

Source: Organization of Economic Co-operation and Development, Development Database on Aid.

Levels of implicit assistance calculated using the second method of f.o.b. unit values are lower than those obtained with the first approach, but the trends are similar. For instance, using the first method implicit assistance averaged 3.9 percent of GDP for the period 1995–2005 for St. Lucia, while the second method calculates implicit assistance as 1.8 percent of GDP (see Table 4.2). The true value of implicit assistance most likely lies between the two measures.

Implicit assistance to Caribbean ACP banana-exporting countries peaked in the mid- to late 1990s. Based on the second approach, income transfers peaked for most Windward Islands countries in the mid-1990s, when they were at least three percent of GDP for Dominica, St. Lucia, and St. Vincent and the Grenadines. These transfers have declined in subsequent years, largely owing to the contraction in the volume of exports, but in 2005 still comprised about 1 percent of GDP for these countries. In contrast, transfers to Belize and Suriname peaked in the late 1990s at about 2 percent of GDP.

Implicit assistance has remained sizable for some Sugar Protocol signatory Caribbean countries, while declining for others (Table 4.3).24 Implicit assistance has remained extremely important in Guyana, averaging nearly 10 percent of both GDP and export receipts. Assistance also remains sizable in Belize, comprising about 2 percent of GDP and about 4½ percent of exports (Figures 4.12 and 4.13). At the same time, implicit assistance has declined as a share of exports and GDP in Barbados, St. Kitts and Nevis, and Jamaica, reflecting increased nonsugar exports and a downsizing of the sugar industry. Implicit assistance was never significant in macroeconomic terms in Trinidad and Tobago, although it served as an important source of income for the rural population. In addition, with the exception of Guyana, Caribbean ODA flows for sugar-exporting countries have declined over the last three decades (Figure 4.16).25

Figure 4.16.Caribbean Sugar Producers: Official Development Assistance (ODA), 1975–2005

Source: Organization of Economic Co-operation and Development, Development Database on Aid.

Table 4.3.Implicit Assistance from EU Sugar Preferences, 1995–2005(In millions of U.S. dollars)
19951996199719981999200020012002200320042005Avg.
Barbados13.820.718.717.520.515.913.413.514.716.214.416.3
In percent of total export of goods and services1.11.61.51.51.61.21.01.11.01.10.81.2
In percent of GDP0.71.00.80.70.80.60.50.50.50.60.50.7
Belize12.719.116.620.122.815.612.116.519.622.519.818.0
In percent of total export of goods and services4.36.25.06.25.53.62.83.54.04.43.54.5
In percent of GDP2.03.02.52.93.11.91.41.82.02.21.92.2
Guyana65.583.465.474.681.060.252.564.376.784.672.371.0
In percent of total export of goods and services10.511.78.810.812.18.97.99.611.511.210.110.3
In percent of GDP10.511.88.810.411.68.57.58.910.310.89.39.9
Jamaica52.759.548.456.066.246.142.041.454.463.245.052.3
In percent of total export of goods and services1.51.81.41.71.91.31.31.31.51.61.11.5
In percent of GDP0.90.90.70.70.90.60.50.50.70.70.50.7
St. Kitts and Nevis7.36.27.55.96.95.05.85.66.96.64.46.2
In percent of total export of goods and services6.24.95.34.14.83.33.83.74.23.41.94.1
In percent of GDP3.22.52.72.12.31.51.71.61.91.61.02.0
TrInidad and Tobago21.721.318.08.722.918.213.718.219.520.421.418.5
In percent of total export of goods and services0.70.70.60.30.70.40.30.40.30.30.20.4
In percent of GDP0.40.40.30.10.30.20.20.20.20.20.10.2
Memorandum items:
EU intervention price, raw sugar, (Euros per tonne)524524524524524524524524524524524524
Free market price, (U.S. dollars per tonne)293264251197138178181138153166222198
EU intervention price (as a percentage of free market price)179199208266379294289381343315236281
Sources: Country authorities; IMF, World Economic Outlook; European Union; and Fund staff estimates.
Sources: Country authorities; IMF, World Economic Outlook; European Union; and Fund staff estimates.

EU trade preferences for bananas and sugar have afforded the Caribbean ACP countries considerable—albeit declining—income transfers in the past. The erosion of these preferences will have macroeconomic implications, which in some cases will be quite significant.

F. The Macroeconomic Impact of Preference Erosion

The macroeconomic impact of preference erosion is analyzed using two different empirical methods: a partial equilibrium model, and a vector autoregression analysis. The main advantage of the partial equilibrium approach is that it combines simplicity with comprehensiveness in terms of allowing for an identification of first-round effects of preference erosion on a range of real, external, and fiscal variables. However, the approach also has its weaknesses, most importantly the fact that it is static, and does not fully take into account all possible interactions between aggregates beyond first-round effects. These shortcomings are the specific advantages of the vector autoregression (VAR) model, which is dynamic and does allow for full interactions between the variables. However, the VAR examines the macroeconomic impact of shocks to implicit assistance afforded by preferences based on historical data. While informative, the method does not take into account the regime change that occurred with the large erosion of preferences.

Partial equilibrium approach

The impact of preference erosion on the trade balance, output growth, and the overall fiscal balance is estimated using a simple partial equilibrium model. The model is based on a national accounting framework and calibrated using assumptions about the evolution of commodity prices and exchange rates, export supply and import demand elasticities, and consumption multipliers (see Mlachila and Cashin (2008) for additional details). The impact of the erosion of trade preferences is obtained by contrasting a baseline scenario for trade, output and fiscal outcomes (that assumes no preference erosion) with an alternative scenario (that incorporates the effect of the erosion of EU preferences).

The erosion of trade preferences will affect export prices received by Caribbean commodity exporters. Overall, the estimates suggest that the new EU banana regime is expected to result in about a 14 percent reduction in the EU price received for ACP banana exports.26 Banana production levels of 2005 are used as the baseline for projections. The export price decline for Caribbean sugar producers follows the time path set out by the European Union, resulting in a cumulative 36 percent decline by 2009.

Reforms introduced by the European Union to their sugar and banana trade regimes will have a large potential impact on some Caribbean countries. This adverse shock will entail adjustment costs that are significant in macroeconomic terms in those countries which have large domestic sugar and banana sectors (relative to exports and GDP). IMF staff projections presented here indicate that these export revenue losses will have direct implications for output and fiscal balances.

Banana exporters

The expected impact of the erosion of banana preferences on output and exports is largest in St. Vincent and the Grenadines and Belize, and least for Grenada. The most significant impact on output is in St. Vincent and the Grenadines, followed by Belize and St. Lucia, while for Grenada output losses are likely to be negligible (given its very limited banana production). The decline in banana prices associated with preference erosion is expected to result in the permanent diminution of export revenues, with the trade balance deteriorating only marginally in most countries owing to an associated import decline.27

Preference erosion is expected to raise overall fiscal deficits in the affected countries (Figure 4.17). The short-run impact is largest in Dominica, with the effect declining in subsequent years. For St. Vincent and the Grenadines and Belize, preference erosion for bananas is expected, over the medium term, to result in a cumulative deterioration of the overall balance of about 0.5 percent of 2005 GDP, while fiscal effects for St. Lucia are slightly lower at about 0.3 percent of 2005 GDP.

Figure 4.17.Caribbean: Impact of Banana Preference Erosion, 2007

(In percent of GDP in 2005)

Source: Fund staff calculations.

Sugar exporters

The decline in sugar preferences is expected to have the largest impact in Guyana (Figure 4.18). The decline in sugar prices is estimated to lead to a cumulative decline in GDP by 2010 when the full reduction in the sugar price has taken place, of up to 6.5 percent of 2005 GDP. This reflects the large impact on export earnings, with the impact on the trade balance more subdued as the decline in GDP is assumed to lead to significantly lower imports. The implications for the fiscal balance are also large.

Figure 4.18.Caribbean: Impact of Sugar Preference Erosion, 2010

(In percent of GDP in 2005)

Source: Fund staff calculations.

Smaller impacts are expected in the other Caribbean countries. The second-largest impact on output, exports and fiscal balances is on Belize. The impact on the other sugar-producing countries is smaller, reflecting the limited role of the sugar industry in these economies. The implication for loss of income is somewhat larger than that for exports because of the multiplier effect. The magnitude of the various effects is smallest for Trinidad and Tobago and St. Kitts and Nevis—for the latter, this exercise cannot measure implications as sugar production ceased in 2005.

It is important to note that the projected macroeconomic implications of preference erosion are static in nature. Over time, affected countries are likely to adjust to the loss in preferences by shifting resources into other sectors of the economy and/or raising the efficiency of their traditional sectors. The ultimate impact on output and income will depend on the success in increasing the efficiency of the reformed banana/sugar sector and on the productivity of the other sectors. In countries with low levels of productivity in their sugar and banana industries, shifting resources into other sectors may well raise overall efficiency and output in the longer term, and therefore ultimately benefit the economy.

Even in countries where the projected macroeconomic implications of preference erosion appear modest, there may be important adjustment costs and adverse social consequences during the transition. These adjustment and social costs would not be captured in the simple partial equilibrium model. For instance, the production of both sugar and banana are land- and labor-intensive, and the expected declines in output may therefore create significant shifts in wages, employment, and land prices. The transition may also trigger important contingent fiscal liabilities, particularly in countries where the production of sugar and bananas is being conducted by state-owned enterprises. These considerations have important implications for policy makers, and underline the importance of developing country-specific responses to facilitate the adjustment and minimize social and economic transition costs.

Vector autoregression (VAR) analysis

A VAR analysis was conducted separately for the banana-exporting Windward Islands, and sugar-exporting Guyana. It reveals large and important macroeconomic effects from shocks to the magnitude of implicit assistance provided through trade preferences.28

Windward Islands 29

For banana exporters, we model a panel VAR of the form:

where yit is a k vector of variables in the system to be estimated; A0Ap are matrices of coefficients; and εtis a vector of innovations. The variables being examined (for the period 1977–2005) for the four Windward Islands are: implicit assistance as calculated above in Section E (IAID), the current account (CUR), gross official reserves (RES), gross domestic product (GDP), and central government revenues (REV). For our system, the yit is a stacked vector of individual country (i=1,…,4)) variables: IAID, CUR, RES, GDP, and REV, in that order.30 This Cholesky ordering is based on a priori notions about the relative endogeneity of the variables, starting with the least endogenous.31 The appropriate lag length for endogenous variables was estimated at five, based on Akaike information criterion results. In what follows, the analysis focuses only on the results of a shock to IAID on other variables.

A positive shock to the level of implicit assistance has an initially positive and significant impact on growth, and external and fiscal balances (Figure 4.19).32 The current account and the reserves growth rate both improve by about 4 percentage points on impact, while real GDP and revenue growth rates improve by about 1½ percentage points. The effect of IAID on the current account and reserves dies out after one year, while that on GDP and government revenues persists longer and dies out after about three years. Following an initial rise in output growth owing to the positive shock to implicit assistance, the persistence of the increase in output growth likely reflects the historical dependence of the Windwards on trade preferences and the export of bananas.

Figure 4.19.Windward Islands: Impulse Response Functions

(Response to Cholesky One-Standard Deviation Innovation in Implicit Assistance)

Source: Authors’ calculations.

Note: The shaded region represents ±2 standard errors.

Implicit assistance also explains a large share of the variability of the macroeconomic variables. Variance decompositions from the estimated VAR model show what proportion of the forecast error variance (at different forecast horizons) can be attributed to the IAID shock. For the Windwards, the variance decomposition reveals that the impact of IAID shocks is strongest for GDP (where it explains about 30 percent of the variance), while for the other variables this peaks at about 20 percent.

Guyana

The estimated impact of a shock to sugar trade preferences (and thereby implicit assistance) on Guyana is sizable (Figure 4.20). Given the importance of the sugar industry in Guyana and the significance of implicit assistance (averaging around 10 percent of GDP between 1975 and 2005) a positive, one standard deviation shock, equivalent to 6.2 percent of GDP, would increase real GDP growth by a couple of percentage points, peak in year three after the shock and slowly diminish over time. The trade balance would experience sizeable fluctuations around its mean, while the revenue to GDP ratio would exhibit an even more pronounced cycle.

Figure 4.20.Guyana: Impulse Response Functions

(Response to Cholesky One-Standard Deviation Innovation in Implicit Assistance)

Source: Authors’ calculations.

Note: The shaded region represents ±2 standard errors.

These results are obtained from a VAR analysis applied to Guyana, where preference erosion is modeled as a one standard deviation shock to the implicit aid transfer that is delivered through preferential sugar prices. The four variables in the VAR regression are: implicit aid to Guyana from trade preferences, expressed in percent of GDP (as calculated in Section E); the external current account deficit (in percent of GDP); real growth rate (in percent); and government revenues (in percent of GDP).

G. Policy Implications

The economic and social implications of erosion of EU trade preferences for banana and sugar are significant for some Caribbean countries. Issues related to preference erosion have been addressed in the Fund’s work on Caribbean-member countries (Box 4.1). While the macroeconomic consequences of the large terms of trade shock engendered by preference erosion have largely already taken place, further development and enhancement of strategies to address the social effects is needed.

Box 4.1.Erosion of Caribbean Trade Preferences in the Work of the IMF

The erosion of Caribbean trade preferences has been addressed in the IMF’s work on surveillance, programs and technical assistance (TA) for Caribbean-member countries, as well as in its research and outreach activities.1 Key points that have been made include:

  • Preference erosion adds an additional layer of vulnerability to Caribbean economies which not only suffer from high exposure to natural disasters, but are insufficiently diversified, and already confront high levels of debt and debt servicing. Some recent Article IV IMF staff reports have quantified the expected macroeconomic impact of the EU erosion of trade preferences, and estimated the export price below which exports of banana or sugar would cease to be viable. Many Article IV staff reports also noted as an additional vulnerability the large discrepancy between the planned allocation and disbursement of donor funds designed to facilitate the transition away from sugar and banana.
  • Adapting a comprehensive strategy in response to the challenge of trade preference erosion is important. Staff have recommended that the authorities use the time prior to the removal of preferences to: enhance international competitiveness; smooth the economic transition by enhancing social safety nets for displaced farmers and agricultural workers; encourage economic diversification; and accelerate structural reforms, in order to raise long-term growth, achieve fiscal and debt sustainability and reduce the external vulnerability of the economy.
  • The economic rationale for public control over the agriculture sector remains weak. As such, even in the cases where privatization/closure of the sector is not politically feasible, the challenge of trade preference erosion makes an even more compelling case for restructuring toward a more streamlined and efficient industry, with increased private sector participation and greater provision of government supporting services (e.g., human resource development, rural infrastructure and better research and development).

Fund technical assistance on issues related to trade preference erosion has served as an important input to Article IV consultation and program work with Caribbean countries. In recent times, Fund TA has largely involved assistance with the design of tax policy and tax and customs administration, particularly assistance designed to tackle the issue of fiscal dependence on trade taxes. Fund TA (delivered jointly with the Caribbean Technical Assistance Center (CARTAC)) has also focused on the introduction of value-added taxes in the region. Finally, future Fund TA in the form of a Poverty and Social Impact Analysis (PSIA) will examine the social and poverty consequences of banana preference erosion in the PRGF-eligible Windward Islands of Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines.

1 Research and analytical work specifically related to the erosion of Caribbean banana and sugar preferences includes IMF (2002); El-Masry (2005); Sahay, Robinson, and Cashin (2006); Mlachila, Samuel, and Njoroge (2006); Atoyan (2006); and Mlachila and Cashin (2007).IMF staff have regularly participated in conferences and seminars related to the erosion of Caribbean trade preferences, including St. Kitts and Nevis Sugar Conference (Basseterre, 2004); Trinidad and Tobago—Caribbean Technical Workshop on adaptation following EU Sugar Reform (Port of Spain, 2005); and Workshop on Macroeconomic Implications of EU Preference Erosion (Washington DC, 2006).

In response to preference erosion—which is unlikely to be reversed—countries need to adopt viable adaptation strategies for their banana and sugar sectors. These industries carry great importance and political weight in policy deliberations, because of their role as major employers (particularly in rural areas), and providers of noncommercial services. Adaptation strategies will need to reflect the particular economic and social circumstances of affected countries. Some countries should enhance their efforts to raise the efficiency and competitiveness of their agricultural sectors, through investment in public infrastructure (including rural roads and ports), sector-specific capital (such as drainage and irrigation systems) and human capital (through training and skill development). For other preference-dependent countries with agricultural industries that exhibit high costs and low productivity, feasible policy options include encouraging diversification away from agriculture to more productive sectors of the economy. Such a shift in sectoral resources will be facilitated by improvements in the investment climate to lower the cost of capital, and greater skills in the workforce. Improvements in social safety nets for displaced farmers and agricultural workers are prominent components of national adaptation strategies—targeted safety nets could include time-bound measures such as income transfers, retraining, and noncontributory pensions (Appendix 4.2).

H. Concluding Remarks

European Union trade preferences for banana exports have afforded Caribbean countries considerable—albeit declining—implicit transfers. Implicit assistance to the Windward Islands peaked at about 15 percent of GDP in the early 1990s, yet with the decline in banana production this assistance declined to about 3 percent of GDP by 2005. Transfers of implicit assistance to Belize and Suriname have averaged less than 5 percent of GDP over the past three decades. In tandem with dramatic declines in official development assistance, over the last 10 to 15 years many Caribbean banana-exporting countries have experienced the loss of annual external assistance flows equivalent to about 8 to 10 percent of GDP.

Income transfers under the EU Sugar Protocol have remained extremely important in Guyana and sizable in Belize. In Guyana estimates of the annual income transfers average nearly 10 percent of GDP. In Belize they comprise about 2 percent of GDP and about 4½ percent of exports. At the same time, the income transfers have declined significantly in Barbados, St. Kitts and Nevis, and Jamaica, reflecting increased nonsugar exports and a downsizing of the sugar industry. They have not been significant in macroeconomic terms in Trinidad and Tobago, although they have served as an important source of income for certain groups of the rural population.

The erosion of EU trade preferences for bananas has had, and will continue to have, an adverse effect on the banana-exporting economies of the Caribbean. Using partial equilibrium analysis, this paper finds a significant adverse effect from preference erosion on the trade balance, economic growth, and the overall fiscal balance. The most severe impact is in St. Vincent and the Grenadines and St. Lucia where the erosion of trade preferences is estimated to lower output over the medium term (vis-à-vis a no preference erosion scenario) by about 1½ to 2 percent from 2005 levels. In addition, the results from a vector autoregressive model also suggest that shocks to implicit assistance (derived from trade preferences) have had a significant impact on economic growth in the Windward Islands.

The decline in sugar trade preferences is expected to have the most significant impact in Guyana, with smaller impacts expected in the other five Caribbean sugar-exporting countries. In Guyana the decline in sugar prices is estimated to engender by 2010 a cumulative decline of up to 6½ percent of 2005 GDP. The second-largest impact is on Belize, where the income decline by 2010 from loss of sugar preferences is estimated at around 1½ percent of 2005 GDP. The impact on the other sugar-producing countries is smaller, reflecting the small role of the sugar industry in these economies, with export earnings estimated to decline by less than ⅓ of 1 percent of 2005 GDP (Trinidad and Tobago, Barbados, and Jamaica).

The full effect of preference erosion is yet to be felt by preference-dependent Caribbean countries. Although much of the macroeconomic impact of banana preference erosion has already taken place, most preference-dependent economies continue to grapple with the ensuing social effects. In particular, incomes and employment prospects for poor rural households, which have limited alternative employment opportunities, have been adversely affected. This suggests the importance of well-targeted social safety nets and transition measures, such as income transfers, retraining programs, and noncontributory pensions. The decline in sugar preferences will be completed over the next several years, and the full macroeconomic effects will only become evident over this time. Countries that envisage closing their sugar industries face similar challenges to those of banana-exporting countries. Those countries that plan to continue production and expand their sugar industries face the challenge of implementing deep reforms and major investment to ensure the industries remain viable in the face of much lower export prices.

Preference-dependent countries should continue in their efforts to raise the efficiency of their agricultural sectors and facilitate the shift of resources into other sectors of their economies. While significant productivity gains in agriculture are unlikely for the Caribbean (with possible exception of Suriname and Guyana), there is scope to orient production toward “fair trade” markets and diversify into nontraditional agriculture.33 In the longer run, many preference-dependent Caribbean economies will need to transition away from agriculture and toward the provision of tourism and financial services, a shift that requires continuing efforts to improve the investment climate, lower business costs and enhance labor force skills (see Sahay, Robinson, and Cashin, 2006).

Appendix 4.1. Data Sources and Issues

Banana prices

Computations of implicit assistance (IAID) to banana producers are based on price differences between protected market prices (United Kingdom/European Union) and free market international prices—the preference margin from exporting to protected European markets.

Unit wholesale prices for the United Kingdom market

These are proxied by:

  • For the period 1975–96: The unit price for banana exports received by the Windward Islands in the United Kingdom. This is the c.i.f. price at the port after offloading and loading on a truck, that is including the port-handling charges. Prices are available until 1999.
  • For the period 1997–2005: World Bank unit prices for EU banana imports (originally sourced from Sopisco News, Food and Agriculture Organization and the World Bank’s own estimates). Specifically, these are the prices of Central and South American bananas—major brands (mainly Dole and Del Monte)—free on truck (f.o.t.) Hamburg, and include discharge costs. Prices also include European Community import taxes. The first year such prices are available is 1997.

As a result, some discontinuity is expected in the series in 1997, owing to (i) differences in discharge costs between Hamburg and London; and (ii) possible differences in rents captured from bananas between Caribbean ACP (Africa, Caribbean, and Pacific) countries and from Latin American banana exporters such as Ecuador, Honduras, and Costa Rica.

International unit prices

These are proxied by:

  • IMF data on banana exports, f.o.b., for the Windward Islands. It is assumed that all banana exports are destined for the United Kingdom (and later the EU) market. Data on export values and volume are taken from the ECCB and WIBDECO, and are available for 1970–2005.
  • The unit price data of “dollar” bananas is proxied by the U.S. import price of bananas from Central and South America, f.o.t., and includes upload charges to truck or rail. This data is available from the IMF’s World Economic Outlook database.

Banana volumes

To calculate the value of implicit assistance (in terms of additional export revenues received by ACP banana-exporting countries), the preference margin for each year is multiplied by the annual volume of exports (in tons) for each country. Data on export volumes for the Windward Islands (Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines) are taken from the Eastern Caribbean Central Bank, and for Belize and Suriname, they are from the Food and Agriculture Organization (FAO).

Sugar prices and volumes

Computations of implicit assistance (IAID) to sugar producers are based on price differences between protected market prices (EU) and world (free market) international prices—the preference margin from exporting to protected European markets.

European Union unit prices

These are proxied by:

  • The unit price data of protected European market sugar is the EU negotiated import price for raw unpacked sugar exported from ACP countries, c.i.f. European ports. This data is available from the IMF’s World Economic Outlook database.

International unit prices

These are proxied by:

  • The unit price data of world (free market) sugar is proxied by the Coffee, Sugar and Cocoa Exchange (CSCE) contract No. 11 (price of nearest futures position), New York City Board of Trade. This data is available from the IMF’s World Economic Outlook database.
  • For comparability and so as not to overestimate the implicit assistance, f.o.b. prices were used. Caribbean f.o.b. prices were derived by removing from the sugar price in export markets (EU and free market) the cost of shipping (estimated by GUYSUCO, the Guyana Sugar Company), based on Sugar Protocal and SPS quota actual shipments.
  • To calculate the value of implicit assistance (in terms of additional export revenues received by ACP sugar-exporting countries), the preference margin for each year is multiplied by the annual volume of exports (in tons) for each country. Data on export volumes for the Barbados, Belize, Guyana, Jamaica, St. Kitts and Nevis, and Trinidad and Tobago are taken from the FAO.

Macroeconomic data

All macroeconomic data (used in the VAR analyses) on gross domestic product (GDP), current account (CUR), international reserves (RES), and central government revenues, excluding grants (REV) are from IMF International Financial Statistics and World Economic Outlook databases, complemented by data from the country authorities. For most variables, data for 2005 is based on Fund staff estimates.

For the Windward Islands: to obtain real domestic variables, all nominal variables are deflated by the national consumer price index (CPI), which is taken from the Eastern Caribbean Central Bank. An exception is nominal GDP, which is deflated by the GDP deflator (base 1990=100) and is taken from the Eastern Caribbean Central Bank. Data on international variables expressed in U.S. dollars such as international prices and exports are deflated by the U.S. CPI. For Guyana: the GDP deflator is used, and is taken from IMF, International Financial Statistics.

Appendix 4.2. Country Adaptation Strategies

Belize

Belize is the only Caribbean country to be significantly affected by trade preference erosion for both sugar and bananas. In the case of sugar, preferences are being eroded by a phased reduction of the guaranteed price in the EU market. For bananas, the European Union has switched from quotas to a tariff-only system that will afford significantly less protection. Overall, the new EU trade regime is expected to result in a 36 percent price reduction for Belize’s sugar exports (to be gradually phased in until 2009) and a price reduction of more than 14 percent for banana exports (starting in 2006).

The banana sector adaptation strategy focuses on sustainable development in the traditional banana-growing areas of Belize by improving industry efficiency and competitiveness through the following projects: (i) upgrading of drainage and irrigation systems and a rehabilitation of farms using tissue culture technology to increase yields; (ii) pavement of highways in the banana belt and enhancement of storage facilities at the Big Creek Port to improve the quality of the banana exports; (iii) enhanced disease management and monitoring to protect farm production from Black Sigatoka disease; (iv) development of an appropriate and comprehensive marketing strategy leading to the establishment of a direct marketing presence for Belize in the European market; (v) development and implementation of a Rural Development Program for all banana industry workers and nearby communities to enhance workers’ ability to attain greater marketability of their skills and self-reliance; (vi) enhanced environmental monitoring program to increase yields; and (vii) increasing the value added through better utilization of “reject” bananas.

Similarly, the sugar adaptation strategy includes actions to raise the industry’s value added and improve operations on the field, at the factory level, and in export operations. Specific actions include (i) increased cane supply through effective deregulation of the cane production system; (ii) improved cane quality through reduced cut-to-mill time, improved harvesting methods and field-to-factory transportation systems, and the implementation of core sampling; (iii) organization of farmers to allow for effective financial and technical resources pooling; (iv) introduction of a new cane payment system encouraging farmers to produce high quality cane; (v) increased capacity to produce packaged direct consumption sugar; (vi) reduction of overall unit costs of production through improved field and factory costs and technical efficiencies and economies of scale; (vi) exploration of options to change the current costly and inefficient mode of transporting sugar from the factory to the ship, including opportunities that may exist in connection with developments at the Belize City Port; (vii) construction and operation of a cogeneration facility at the Tower Hill sugar plant to supply power and sell some to the national grid as of mid-2008; and (viii) pursuit of plans for alcohol/ethanol production to add value to molasses, which are currently mostly exported. In addition to these measures, Belize has requested an increase of its market allocation from 42,000 tons to 100,000 tons to secure additional access to the EU market.

The Belize Sugar Adaptation Strategy is a welcome addition to ongoing efforts to improve living standards in the sugar belt in Northern Belize. It strengthens efforts to enhance competitiveness in the sugar sector and address broader adaptation needs. The government remains committed to the European Union’s eight year assistance strategy (2006–13), which will provide €3 million in funding. The financing agreement for the EU Banana Support Programme forms an integral part of the competitiveness strategy for the banana industry. It supports ongoing efforts to improve efficiency and productivity in the industry, as well as improving living standards in banana-growing areas. Since its inception, Belize has been allocated over € 21 million through the program.

Guyana

The sugar sector plays a central role in Guyana’s economy. It is the largest net earner of foreign exchange, accounting for 23 percent of total exports and 18 percent of GDP in 2006. It is also one of largest employers, with employment of about 7 percent of the total labor force. The sector also contributes significantly to government finances, although its contribution in recent years has declined owing to a shortfall in production as a result of adverse weather conditions. It is comprised of a single state-owned enterprise, the Guyana Sugar Corporation (GUYSUCO).

GUYSUCO developed a comprehensive restructuring plan in the early 2000s to significantly increase productivity. The plan—which was developed with the help of the World Bank—was intended to address the high cost of the sector, in part, in anticipation of changes in EU trade preferences. The main focus was on increasing production in the lower cost areas by improving field-level productivity, to reduce average cost in the industry from about 24 U.S. cents per pound to 15 U.S. cents per pound by 2010. At its center was the construction of a modern large-scale factory at Skeldon with annual capacity of 110,000–130,000 tons of sugar. After long delays associated with government efforts to obtain concessional financing, re-tendering and modification of the original project, the construction of the factory began in 2005 and the factory is expected to be completed in early 2008. The total cost of the project is US$167 million (22 percent of 2006 GDP). GUYSUCO is also implementing an Agricultural Improvement Program with assistance from the Caribbean Development Bank to boost field-level productivity though better agricultural practices and increased mechanization. The program aims at increasing per-hectare cane yields by 30 percent and at the same time raise the sugar content of the plants by 10 percent.

The government presented its National Action Plan for the Sugar Industry in 2006, as a basis for EU support of countries’ adjustments strategies to the decline in sugar preference prices. The plan was prepared in a consultative process with a broad range of stakeholders, and is based on GUYSUCO’s long-term business plan, building on its ongoing reform and restructuring efforts, while significantly augmenting the value added in the industry. As part of the plan, GUYSUCO intends to rehabilitate and expand some factories to accommodate an expected 60 percent increase in production by 2010. Nevertheless, repeated flooding has already delayed the achievement of these targets. Over the next few years, a priority project is the construction of a packaging plant at Enmore to supply the Caribbean market. Other long-term projects include the construction of an ethanol production plant, a deep water berth; and two additional cogeneration facilities. The government is studying several proposals from international private investors to develop some of these projects.

The proposed strategy has the potential to maintain the financial viability of Guyana’s sugar industry in the face of the EU sugar market reform, but is subject to serious risks. These include vulnerability to adverse weather conditions, which, as noted above, has already delayed the attainment of the high production targets as well as the reduction in per-unit cost. The strategy’s dependence on preferential trade agreements is another potential source of vulnerability. GUYSUCO’s expansion into the CARICOM market relies heavily on the applicability of the 40 percent Common External Tariff (CET). The announcement in early 2007 by Trinidad and Tobago of plans to close its sugar industry could make it difficult for GUYSUCO to invoke the CET.34 Finally, delays in the delivery of the EU support and other financing could affect key projects to be carried out during 2007–10.35

Guyana’s adaptation strategy will go a long way to improve the long-term competitiveness of the sugar industry. The strategy appropriately focuses on improving the productivity of the state-owned sugar company and creating value added in the industry. However, critical investments and restructuring need to be implemented in a timely manner if the industry is to remain financially viable by 2010, when the new EU regime will come into force. The European Union’s commitment to provide budget support to fund part of the strategy is a positive development but care will be needed to ensure that these finite resources are used to achieve lasting improvements in the sector. While the strategy envisages important reductions in production costs, efforts will be required to further reduce labor costs and enhance industry competitiveness in the face of further liberalization of protected markets. Finally, the recent promotion of greater private sector participation in the restructuring process is welcome but fiscal risks arising from private public partnerships will need to be contained to safeguard the authorities’ medium-term objective of achieving fiscal sustainability.

St. Kitts and Nevis

In July 2005, the sugar industry—the historical mainstay of the economy—closed after more than 300 years. The industry had incurred substantial losses—on the order of 3–4 percent of GDP annually in the previous several years—even before the announced further cut in preferential access to the EU market. The sugar industry had occupied about 9,300 acres of land (about a quarter of the land surface of St. Kitts) and employed about 1,400 workers (9 percent of the labor force). The closure has required the government to takeover the debt of the sugar company (about 29 percent of GDP).

Considerable long-term economic benefits are anticipated, but there will be significant transitional costs. Key benefits are likely to stem from the release of land and labor resources to more productive uses, thereby raising growth potential, as well as halting the incurrence of quasi-fiscal losses that were aggravating an already difficult debt situation. Transitional costs include:

  • The severance package for the 1,406 sugar workers was generous and cost about EC$27.4 million (2.3 percent of 2005 GDP). Rather than abiding by the 1986 Protection of Employment Act, which limits severance payments to a maximum of 52 weeks’ pay, eligible workers received severance payments up to 104 weeks’ pay, as under the Severance Agreement of 1961.
  • The government is servicing the debt of the St. Kitts Sugar Manufacturing Company (SSMC), increasing the central government interest bill by 1½ of GDP a year. The debt is in the form of a 30-year bond at 5.2 percent interest rate and principal repayments are scheduled at US$57 million every five years. The debt is secured by approximately 4,700 acres of land.
  • Transfers to former sugar workers are set to increase over the medium term. Under the severance agreement, the sugar workers will receive medical care under the National Health Programme, and the SSMC pensioners will be transferred to the Social Security Scheme with the guarantee that their pensions will not be reduced. In addition, land has been allocated to workers who wanted to become farmers, and a housing scheme is to be implemented for workers with long tenure (20 years or more) who do not own homes and have income levels below the poverty line.

The near-term impact on growth and foreign exchange earnings is estimated to be modest. Sugar export proceeds had declined to an average of 2½ percent of GDP a year during 2000–04, with a limited contribution to value added in the economy.

Transition costs may be offset by two factors:

  • The booming economy and initial low level of unemployment has enabled quick absorption of most workers into the labor force. A survey conducted by the Sugar Transition office in May–June 2006 found that only 317 former workers were unemployed.
  • The European Union has pledged grant support to African Caribbean Pacific (ACP) sugar producers affected by the erosion of trade preferences. The support for 2006 is in the form of project assistance of €2.8 million. For the period 2007–10, the support will be in the form of general budget support of €42.3 million, with policy conditions to be finalized.

The authorities have developed a comprehensive strategy for dealing with the transition from sugar. The strategy covers a broad range of economic, social and environmental measures that aim to diversify and improve the competitiveness of the economy. It includes developing high-end facilities for tourism, strengthening land development agencies, enhancing linkages between the agriculture and tourism sectors, and empowering vulnerable groups. The European Union has reviewed and approved the strategy.

The adaptation strategy has laid the foundation for improving competitiveness and enhancing growth. The strategy rightly identifies tourism as the main driver of the economy. While the public sector could play a key role in providing essential infrastructure, the private sector should take the lead in developing the tourism sector. Moreover, given the very high public debt level, public investment should be based on rigorous cost-benefit analysis and financing availability. Strengthening land development agencies is welcome, but consideration should be given to transferring lands to the private sector for more productive uses. Finally, efforts to empower vulnerable groups need to be well targeted and balanced against the fiscal costs.

Windward Islands

The Windward Islands’ adaptation strategies for the banana sector focus on diversification, assistance to banana farmers for expansion, and niche-production.

  • Diversifying away from banana production. Governments in the Windward Islands have established agricultural diversification programs to stimulate the modernization and competitiveness of nonbanana crops—such as root crops in St. Vincent and the Grenadines or passion fruit and hot peppers in Dominica. Policy actions implemented by the authorities include (i) the procurement of equipment, implements and appropriate technology; (ii) providing irrigation infrastructure; (iii) facilitating farmers’ access to credit; and (iii) setting up of value-added facilities such as the refurbished arrowroot factory in St. Vincent and the Grenadines. The European Union has pledged to support these efforts, but so far the level of disbursements has been very low.
  • Helping the banana industry to increase its production. Because of its socioeconomic importance, some governments in the region—particularly that of St. Vincent and the Grenadines—intend to help the banana industry modernize and increase its production. Policies undertaken with this aim include (i) subsidizing key inputs (particularly fertilizers); (ii) paying off the debt of banana producers’ associations; (ii) exempting farmers’ incomes from tax; (iii) the establishment of WIBDECO (Windward Islands Banana Development and Exporting Company) as a marketing agent and partial owner of the shipping service; and (iv) making a bonus payment to farmers who sell bananas to WIBDECO.
  • Moving production to “fair-trade” bananas. The authorities’ medium-term plans for the banana industry entail producing high-quality bananas for export to Europe that qualify under “fair trade” or “organic” labels and thereby satisfy a niche market that will garner higher prices. Banana production in the Windward Islands has largely switched from conventional exports to fair-trade exports. It is estimated that this movement has granted a price-premium to banana producers of around 30 percent over nonfair trade prices.

These adaptation strategies have offered some relief to banana producers but are unlikely to prove a sustained source of growth in the medium term. The movement to fair-trade bananas has boosted production in the short-run, but as more efficient Central and South American producers have increasingly qualified as fair-trade producers the premium currently enjoyed by Windward Islands has been eroded. Efforts to diversify agricultural production away from bananas have suffered from a very low disbursement of EU support, while subsidies to key inputs have been more than offset by a sharp increase in the price of fertilizers.

Beyond these initiatives, social safety nets in the Windward Islands have been enhanced. Targeted social safety nets and transition measures have been implemented, particularly in poor rural communities where incomes have declined significantly and unemployment risen.

  • Income transfers to former producers. Poor rural households, which have limited alternative employment opportunities, have received direct income transfers. In St. Vincent and the Grenadines about 5,000 farmers have received a monthly cash stipend of EC$125 for those over 65 years of age.
  • Noncontributory pensions and housing schemes. Complementary measures to direct incomes transfers such as noncontributory health care and pension benefits, are also being considered in St. Vincent and the Grenadines and St. Lucia. The experience of the sugar industry of St. Kitts and Nevis offers and example of this. Under their severance package sugar workers will receive medical care under the National Health Program, and their pension will be assumed by the Social Security Scheme with the guarantee that their pensions will not be reduced. In addition, a housing scheme is to be implemented for workers with long tenure who do not own homes and have income levels below the poverty line.

Social safety nets, however, could be furthered strengthened through greater consolidation, more transparency, and better data. Governments in the region currently implement a large number of social assistance programs that are largely overlapping and administratively cumbersome, and are consequently expensive and inefficient in targeting the needs of the most vulnerable groups. Furthermore, poverty and household surveys in the Windwards are typically outdated—the exception being St. Lucia—making more difficult the identification and construction of a well-targeted system with clear and transparent criteria.

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1This chapter has benefited from contributions from Pelin Berkmen, Pawel Dyczewski, Nkunde Mwase, Catherine Pattillo, Emilio Pineda, Mariana Torres, and Evridiki Tsounta, along with analytical work carried out by Katerina Alexandraki, Ruben Atoyan, Hans Peter Lankes, and Azim Sadikov.
2The 11 Caribbean countries examined include Dominica, Grenada, St. Lucia, St. Vincent and the Grenadines, and Suriname (banana-exporting countries); Barbados, Guyana, Jamaica, St. Kitts and Nevis, Trinidad and Tobago (sugar-exporting countries); and Belize (exporter of both bananas and sugar).
3Data sources are provided in Appendix 4.1. A review of recent literature, the technical derivation of estimates of the value of preferences, and the export impact of the erosion of EU preferences for the banana sector can be found in Mlachila and Cashin (2008). The partial equilibrium framework that has been used to estimate the macroeconomic effects of trade preference erosion is also discussed in Mlachila and Cashin (2007).
4The Windward Islands comprise Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines.
5The number of registered banana growers in the Windward Islands has fallen from about 24,000 farmers in 1993 to about 5,000 in 2004, with the number of workers deriving income from banana production exceeding the number of farmers by a factor of three. Despite these declines the industry remains a major employer, particularly in rural regions (IMF, 2001; NERA, 2004).
6For a comprehensive description of problems faced by Windward Islands banana producers, see Sandiford (2000) and Myers (2004).
7In particular, the United Kingdom allowed duty free access for bananas from Caribbean ACP countries of Dominica, Grenada, St. Lucia and St. Vincent and the Grenadines, Jamaica, Belize and Suriname. For an historical study of the Caribbean banana trade, see Clegg (2003).
8See Borrell (1999), Guyomard and others (2004), and Williams and others (1999) for analyses of the economic effects of the Single European Market.
9The shift to a tariff-only regime has engendered considerable controversy regarding what level of tariff protection would be equivalent to the previous quota-based regime, particularly as it pertains to maintaining market access for non-ACP suppliers. Previous EU proposals of a single MFN tariff of €230 per ton and later €187 per ton were challenged by Latin American banana exporters, and both were rejected by WTO arbitrators on the grounds that the tariff would not at least maintain total market access for MFN suppliers.
10In November 2006, Ecuador (the world’s largest banana exporter) formally initiated a process to challenge the current level of the MFN tariff (€176 per ton) before the WTO. On June 29, 2007 the United States lodged a complaint to the WTO, requesting a WTO panel to review the European Union’s banana-importing regime, stating that it harms exports from Latin American countries.
11The Special Framework of Assistance (SFA) was established in 1999, when the preferential trade arrangements traditionally enjoyed by ACP banana producers were found to be incompatible with WTO rules, to help the twelve ACP traditional banana suppliers (including the four Windwards countries and Belize) adapt to the new market conditions.
12The sugar reform does not alter the provisions of the Sugar Protocol, and ACP countries will continue to have preferential market access to EU markets at zero duties with a guaranteed price.
13One of the traditional sugar-exporting Caribbean ACP countries, St. Kitts and Nevis, ceased production of sugar following the harvest of 2005. Similarly, Trinidad and Tobago announced in early 2007 that it was developing an exit strategy from sugar production, following its 2007 harvest.
14Strategies for diversification and transformation include adding value through the development of sugar refining and Caribbean brand packaging; diversification into energy sectors such as bio-ethanol; sustaining supplies of raw material to the rum industry; and recognition of sugar’s place in tourism, soil conservation and enhancing the environment.
15The total allocation for the period 2007–10 is €667 million for the 18 Sugar Protocol countries, allocated among the Caribbean as Guyana (€ 84 million); Barbados (€35 million); Belize (€45 million); Jamaica (€78 million); St. Kitts and Nevis (€42 million); and Trinidad and Tobago (€42 million).
16For a more detailed review of the literature on preference erosion, see Mlachila and Cashin (2008).
17Alexandraki and Lankes (2004) examine the effect on middle-income countries and assume a hypothetical 40 percent cut in the preference margin for exporting countries; Subramanian (2003) focuses on low-income countries and assumes a 40 percent reduction in MFN tariffs in export markets.
18Amiti and Romalis (2006) also find significant negative impacts of preference erosion on the Windward Islands, owing to their assumption of an infinite supply response.
19For example, two important analyses are those of Vanzetti and others (2004), and Borrell and Bauer (2004). These contributions differ in assumptions on values and distribution of quota rent, price elasticities, and exchange rates.
20This section draws upon Atoyan (2006), and Mlachila and Cashin (2007). Additional details are provided in Appendix 4.1.
21This computation is likely to be the lower bound of the true price gap, as the use of f.o.b. Caribbean and world market prices does not reflect likely differences in the efficiency of transport and insurance between ACP suppliers and their competitors on world markets.
22This methodology assumes that the entire rent from the trade preference accrues to the exporting country (which tends to overestimate the implicit transfer) and that world (international) prices are not affected by preferences (which tends to underestimate the implicit transfer).
23This method will also tend to overestimate the true preference margin, as both price series include transport, insurance and discharging costs, which are typically higher in EU markets relative to those of U.S. markets.
24Since there are two different EU raw sugar prices, one for the Sugar Protocol and the other for the SPS sugar, calculations were based on actual shipments of sugar under each of these schemes.
25Implicit assistance to sugar exporters was also calculated according to formulation in Equation (2). For sugar, a single price differential is used in the computation. The wedge is the difference between the announced minimum EU raw sugar price and the world free market price (derived from contracts traded on the Coffee, Sugar and Cocoa Exchange, New York), both expressed in U.S. dollars and on a f.o.b. basis. For additional details, see Mlachila and Cashin (2008).
26This estimated price change is close to that derived by National Economic Research Associates (2004), which was calculated using price-gap methods.
27All projections are based on the assumption of a MFN tariff of €176 per metric ton from 2006 onward. The projections also assume, implicitly, that transport will remain available at affordable costs. However, below a certain volume threshold freight costs may become prohibitive, which would result in a far sharper contraction of banana exports.
28An advantage of the VAR-type reduced form approach is the ability to exploit historical dynamics observed in the data to assess the likely macroeconomic impact of the erosion of trade preferences. See Deaton and Miller (1995), which uses this approach to estimate the impact of commodity price shocks on components of GDP in African countries.
29This section draws upon Mlachila and Cashin (2007).
30All variables are in real terms (see Appendix 4.1) for a full description and derivation of the data).
31Cointegration tests reveal that the no co-integration null hypothesis cannot be rejected (at the 5 percent level of significance); consequently, a VAR in first differences appears appropriate. In addition, robustness tests involving different ordering of variables did not lead to significantly different results.
32The impulse response functions focus on the dynamic effects of shocks to implicit assistance. All simulations are performed considering a one standard deviation transitory shock to implicit assistance (IAID) and its impact on macroeconomic variables in the decade following the shock.
33Diversification into nonbanana and nonsugar agriculture is made more difficult in the Caribbean owing to their vulnerability to natural disasters; topographical impediments; small domestic markets; and high transportation and business costs.
34The CET for refined sugar protects CARICOM sugar producers if they can supply at least 135,000 tons to the CARICOM market. GUYSUCO planned to build a 120,000 ton refinery under the assumption that Trinidad and Tobago would provide the remaining tonnage.
35See also Evans and others (2006), who identify the amount of transitional assistance needed under the EU sugar framework for 2007–13 to enable four Caribbean countries (Guyana, Jamaica, St. Kitts and Nevis, and Trinidad and Tobago) to successfully manage the adjustment process. They find that, in comparison with planned EU allocations, the Sugar Action Plans in the former two countries would be “under-funded” while the latter two countries would be considerably “over-funded.”

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