Part 2: Economic convergence in the Caribbean?

In the previous column (Apr 2, 2014), we observed two ideas relating to the origins of money – the Metallist view and the Chartalist view. This classification scheme was given in a published article written by Charles Goodhart, an economist who does work on real life issues. It was noted that many of the institutional arrangements of cooperation in CARICOM are consistent or motivated by the Metallist view (M-theory) of the origin of money. One example would be the movement of skilled labour. The basic idea is to allow for the mobility of labour within the region so that over time there can be a convergence of business cycles across the region.

Another perspective – but largely ignored in orthodox economics – is the idea that money is a creature of the state. A viable state needs to raise taxes. Indeed, the data will show that all the weakest and failed states in the world collect a very small percentage of GDP in taxation. The state requires that the citizens pay taxes in a currency it declares to be money; hence the more historically consistent view of money, according to Goodhart. The core policy conclusion of the Chartalist perspective (C-theory) implies that for a region to have a common currency – known as an optimal currency area – it must first make credible steps towards some form of fiscal and/or political union. On the other hand, the core policy conclusion of M-theory is money is just a means for making payments; that a currency can be created in a region without significant fiscal integration.

C-theory will imply a taxing authority should come first before a regional central bank. Metallism implies a regional taxing authority is not essential and a central bank could be established once there is labour mobility, sufficient intra-regional trade and intra-regional capital movements. Those who adhere to Metallism tend to have greater faith in unregulated markets and the power of monetary policy to influence the real economy such as employment and GDP. Those who look to Chartalism for guidance will be more sceptical of the ability of a regional central bank to get these things done. Indeed, the limited movement towards greater convergence in CARICOM signals one grand market and coordination failure. A market can hardly correct a market failure without some coherent plan to get the market process moving.

development watchA central bank is better at maintaining prudent management of money and trying to meet some inflation target, which in our type of economy has to come through exchange rate stability. It can only stimulate employment and GDP growth indirectly through maintaining macroeconomic stability. It cannot print money to spend beyond the productive capacity of the society without risking serious consequences. Furthermore, without regional production integration there cannot be a convergence of the different business cycles of CARICOM. Even the United States central bank found out that in spite of creating vast amounts of liquidity it at most stimulated financial asset prices without any substantial favourable impact on the small man; instead the central bank might have worsened asset inequality in that country and in some emerging economies.

As we noted in the previous column, Minister Winston Dookeran resurrected the idea of production integration in CARICOM as his concept of convergence. Production integration and intra-regional trade are definitely crucial and can surely drive more labour and capital mobility towards greater economic convergence. The crucial question is, however, from where would the money come to finance production integration? Foreign aid can never achieve this task; aid furthermore involves making some terrible foreign policy compromises and also compromises in the areas of good governance and transparency as we have seen in Guyana.

Perhaps the only way to get this done is through gradual steps towards fiscal integration and coordination. This does not merely imply making taxes more consistent across the region, as is the case right now. A step in that direction should be gradual, thus possibly making the proposal politically palatable. One possibility is to have a regional body that will take the first steps towards a regional economic planning unit with the intention of financing production flows across the region. The unit could be given the authority to levy and collect a 1% consumption tax across the region. VAT and consumption taxes are fairly high in some countries; hence setting up a political veto. Those with taxes above 14% should lower theirs to 13%. Those with VAT and C-taxes below 12% will just add the 1% CARICOM tax. Future work would be needed to clarify how much revenue 1% will bring in. Nevertheless, the idea is to pin down region wide psychology and expectation that come with fiscal convergence.

Subtracting the annual expenses and salaries associated with the regional economic planning unit leaves the agency with a stock of liquid financial assets collected in taxes in various currencies from different countries. Therefore, on the liability side the planning unit could be a regional currency, which for convenience we can call Caribbean dollars (Cari$). One unit of Cari$ will be indexed as a weighted average of all the regional currencies collected at their present exchange rate. Cari$ will be empowered to be accepted and spent in any country of CARICOM, thus making it easy to finance any activity that will stimulate regional production integration.

Cari$ must be used as much as possible for intra-regional transactions to bypass the use of US dollars, Euros and other hard currencies. Of course, the foreign currencies like the US dollar are still required for global transactions outside of CARICOM. The regional planning unit does not have the power to issue unlimited amounts of Cari$ as a pure central bank would. Therefore, it is forced to be frugal and the country central banks are still incentivised to maintain exchange rate stability of their respective currencies so that Cari$ can remain stable.

On the issue of political turf battles, no central bank in CARICOM is replaced and each country still maintains its fiscal authority. The economic planning unit should be tasked with coming up with a transparent list of projects that can be financed only (or mainly) with Cari$, and also justify why the project is needed in a particular territory at a particular time. Most important is to get into people’s mind that there could be a stable CARICOM currency, thus paving the way for a full-fledged central bank one of these good days.

Comments: tkhemraj@ncf.edu