Introduction
As far as policies promoting economic development go, I can think of few more important than greater economic integration of CARICOM. Each economy is too small to weather the global storms separately; furthermore, deeper Guyanese integration into Latin America is no panacea, although some economic cooperation with that region is necessary for strategic reasons. It is for this reason we must examine, interpret and extend Minister Winston Dookeran’s essay “New Caribbean convergence model”.
The economic growth literature has a specific interpretation of convergence. It implies that given a common technology a group of economies trading together will eventually witness the per capita income of all the countries in the said group converging in terms of per capita income. However, there can be divergence in income – meaning some stay poor while others get rich – if some economies possess superior technology and human capital while others do not.
The question remains how to achieve the convergence in average income and living standard in CARICOM. Mr Dookeran suggests this can be achieved through production integration. He is absolutely correct. It is for this reason two of the founding thinkers – Dr Havelock Brewster and Professor Clive Thomas – worked out the theory behind production integration in a monograph published in 1967: “The Dynamics of West Indian Economic Integration”.
Financing convergence
The question remains how is the production integration going to be financed? I will examine one possibility of financing integration and greater mobility of goods and production inputs within the region. The specific financing method will be presented in the next fortnightly column. This one looks at the theory underpinning the financing method. Theory is important because without a sound theoretical basis we are just being tossed by the wind in different directions. The proposal should be a precursor for the Caribbean central bank and a common currency, which itself is based on a theoretical idea known as the optimum currency area (OCA). Indeed, a central bank has a mandate of price stability which does not necessarily coincide with a financing plan of production integration.
Having a central bank and a common currency do not guarantee that there will be convergence and integration of production, or that the currency can survive the kind of shock the Euro currency area recently faced. For instance, a Caribbean central bank will be hard-pressed to find an instrument of monetary policy such as a benchmark policy interest rate which it can use to influence a uniform Caribbean business cycle.
Two concepts of money
Charles Goodhart, my favourite monetary economist, published a crucial paper in 1988 in which he outlined two views about the history of money. The name of the paper is: “The two concepts of money: implications for the analysis of optimal currency areas”. Here Goodhart argues that there is an M theory and a C theory of money, where M stands for Metallist and C for Chartalist. M theory argues that money evolved historically because private individuals bartering in a free market needed a common currency that can be used to make payments. As elementary economics students know, the barter system is beleaguered with inefficiencies and high transaction costs. Having a common medium of exchange like gold, silver or whale teeth can reduce these transaction costs and facilitate the development of markets.
Goodhard notes that the Euro currency and the European Central Bank are premised on M theory. In other words, M theory and its corollary OCA motivate European monetary union. I would extend this argument to the proposed idea of Caribbean monetary union, which is certainly on the backburner these days. In keeping with OCA and M-theory, Caribbean governments have produced laws and systems to make skilled labour mobile across the region. In addition, steps were taken early to ensure trade liberalization within CARICOM. More recently a Competition Commission was established to make sure that there is free competition in the region and to prevent unfair treatment of small enterprises. These are all mechanisms consistent with OCA theory.
Although far off into the future, a common currency in CARICOM – according to OCA theory – could be established once there is ample trade flows and free labour movement within the Caribbean community. The flow of trade and labour are supposed to make Caribbean business cycles converge for the purpose of monetary management by a single central bank. In other words, M theory ignores the importance of political convergence.
On the other hand, Goodhart argues that C theory is a more historically accurate view of the evolution of money. Money is a creature of the state or the monarchy. When kings and governments wanted to raise tax revenues they declare a common unit in which the tax will be collected. The king now has the power to purchase any commodity from the masses with money he declares to be money. Private traders found the common unit useful relative to barter. C theory, one can say, would place political union of CARICOM at the centre of the analysis. In other words, there will have to be a common Ministry of Finance with a CARICOM Minister of Finance before there can be a central bank and common currency. The minister will need to have a system of taxation and spending for the entire region. Tax harmonization, the present focus in the region, would not be enough in the world of C theory.
These radical ideas would be very difficult to implement at this point. But it does not imply C theory has no useful insights for understanding how convergence could be financed since as I have noted above a common central bank cannot finance convergence of production and trading systems. C theory, moreover, provides useful insights for introducing monetary and financial systems that will allow for a more stable common currency to eventually evolve in CARICOM.
Middle road proposal
Recognizing the political difficulties and inertia, the next column will argue in favour of a middle-of-the road system for financing convergence. Suffice to say, if the region continues to move towards a monetary union without some form of union on the fiscal side, it would not survive the kind of shock the euro took recently. Some argue that the deflation in the Eurozone came about because of the lack of the common capacity to spend, run deficits and tax.
Operating in deeper and more developed financial markets, the European Central Bank purchased some government bonds of the affected countries.
This effort, however, was stringently resisted in some quarters because it was seen as a violation of the mandate of the central bank, even as Portugal, Ireland, Greece and Spain burned. Indeed, bond yields (risk spread) did decline when the European Central Bank purchased some of the stressed government bonds.
A Caribbean central bank operating under similar stress will not have the luxury of a deep and liquid bond market as the region is more naturally prone to a system in which a few large commercial banks operate. This implies that the hypothetical central bank would have to buy stressed Treasury bills and bonds from the stressed regional governments, as none at the Caribbean level exists. This will lead to isolated easing of risk spreads that will not transmit throughout the region in time of a crisis.
Comments: tkhemraj@ncf.edu
