EAST-WEST CENTER WORKING PAPERS Identifying Binding Constraints in Pacific Island Economies RON DUNCAN and HILARIAN CODIPPILY with EMELE DUITUTURAGA and RAIJIELI BULATALE WORKING PAPERS Pacific Islands Development Series _____________________________ No. 18, November 2014 Identifying Binding Constraints in Pacific Island Economies RON DUNCAN and HILARIAN CODIPPILY with EMELE DUITUTURAGA and RAIJIELI BULATALE THE EAST-WEST CENTER promotes better relations and understanding among the people and nations of the United States, Asia, and the Pacific through coopera- tive study, research, and dialogue. Established by the US Congress in 1960, the Center servers as a resource for information and analysis on critical issues of com- mon concern, bringing people together to exchange views, build expertise, and develop policy options. THE PACIFIC ISLANDS DEVELOPMENT PROGAM (PIDP) was established in 1980 as the research and training arm for the Pacific Islands Conference of Lead- ers—a forum through which heads of government discuss critical policy issues with a wide range of interested countries, donors, nongovernmental organizations, and private sector representatives. PIDP activities are designed to assist Pacific Island Leaders in advancing their collective efforts to achieve and sustain equitable social and economic development. As a regional organization working across the Pacific, the PIDP supports five major activity areas: Secretariat of the Pacific Islands Con- ference of Leaders, Policy Research, Education and Training, Secretariat of the United States/Pacific Islands Nations Joint Commercial Commission, and Pacific Islands Report (pireport.org). In support of the East-West Center’s mission to help build a peaceful and prosperous Asia Pacific community, the PIDP serves as a cata- lyst for development and a link between the Pacific Islands and the United States and other countries. Published by the East-West Center Publication Sales Office East-West Center 16001 East-West Road Honolulu, Hawai‘i 96848-1601 USA Tel: 808.944.7145 Fax: 808.944.7378 [email protected] EastWestCenter.org ISSN ISBN © East-West Center 2014 PREFACE The emergence of a large number of small states over the past four decades or so (there are presently around 50 states with populations with less than 1.5 mil- lion) has led to considerable interest amongst researchers, member govern- ments, and international agencies in their economic and environmental viabil- ity. The literature generated in the process has focused on the special problems and development challenges faced by such states, including their prospects for integration with the changing global environment. The study presented here builds upon this literature in examining the binding constraints to develop- ment. It is our hope that this study will benefit policy makers, researchers, and the donor community. Rather than using the conventional ‘saving-investment-production function- growth’ approach, combined with a fiscal, monetary, exchange rate, and regu- latory policy framework, the study explores issues that underlie these policies and discusses why policies that work elsewhere may not work in Pacific island countries (PICs). The ineffectiveness of policies may be because of the preva- lence of strong cultural traditions that play an important role in areas such as land ownership, sharing of economic resources, protecting the environment, providing a social safety net, fostering social cohesion, and maintaining law and order at the local level. ‘Rules of the game’ defined by such small but complex systems—which coexist with formal government structures—present difficul- ties for the establishment of a market economy because markets are based on transactions between parties who do not know each other. These traditional systems also have implications for donor-funded projects. A suitable frame- work and a deep knowledge of such cultural traditions are therefore essential for understanding why market-oriented prescriptions or foreign-aided projects may or may not always work. In this study, we use a modified form of the analytical framework proposed by Hausman, Roderick, and Velasco (2004), which, in some cases, is extended by the Institutional Analysis for Development (IAD) framework pioneered by Ostrom et al (2001). In doing so, the study makes a radical departure from con- ventional quantitative approaches and focuses on the ‘deep determinants’ of growth. The study recognizes explicitly the political economy based on cul- tural traditions in small island economies such as in the Pacific as well as the paucity of economic data in these countries; thus shifting the research effort in a qualitative direction. The research undertaken is presented in this book in the form of analytical country narratives covering political, legal, regulatory, insti- tutional, economic, and cultural factors that have either inhibited or facilitated the development process. The analytical framework of Hausman, Roderick, and Velasco (HRV) is based on the assumption that an under-performing economy is constrained by mar- ket imperfections and distortions arising from imperfections and distortions from government interventions or from other market imperfections and from externalities. Removal of all distortions at once is one approach to economic reform, but this requires knowledge of all distortions and also poses the politi- cally impossible task of removing them all at once. This study seeks to identify binding constraints based on investigations in a selected set of small island economies within broad categories of determinants of growth, such as avail- ability of savings, availability of human capital, and returns to investment, aided by a decision tree diagram. It is argued that there are usually many factors hindering improved economic growth but that it is necessary to remove the most constraining first for a reform program to be effective. This framework is similar to the logic of linear programming, which identifies the most binding constraint as the one with the highest shadow price or opportunity cost. There- fore, relaxing that constraint will have the highest payoff. Once it is relaxed, another constraint will become the most binding. The IAD framework provides a very productive means of gaining an under- standing of the behaviour of the groups that have an influence, for better or worse, on economic development within a country. It extends the HRV analy- sis, which is essentially an economic analysis, into political, cultural, and social areas—what might be called the broader political economy of a country—as constraints on growth may exist at the underlying ‘institutional’ level rather than at the economic level. The IAD framework assumes that most problems in development result from the inability of people to take collective action, espe- cially in regard to the delivery of public goods and the effective management of ‘common pool’ resources. Four Pacific island countries were chosen for detailed study of the factors un- derlying their economic success, or lack of it: Fiji, Kiribati, Samoa, and Cook Islands. The choice of the four countries studied was based on two main crite- ria: economic performance and the geographical, ethnic, and migratory fea- tures that distinguish these countries. Fiji and Kiribati have both carried out economic reforms, but not of the comprehensive nature of those of Samoa and Cook Islands. It is of interest therefore to compare the results of the reforms undertaken across the four countries and try to understand the reasons for the different results. For comparative purposes, two small island countries were chosen from outside the Pacific region: Barbados and Maldives. Barbados has been seen as a model for developing countries by virtue of its traditional ap- proach to development over a long period of time, achieving a relatively high level of per capita income and quality of life for its people. Maldives, by con- trast, is a case where notable results have been achieved in growth and develop- ment in a relatively short period of time, based on a ‘leading sector approach’. The country visits for this research study were initiated in 2008 and completed in 2010. These country visits provided the opportunity for the two main au- thors and their associates to interact with policy makers, researchers, and civil society in these countries and carry out in-depth studies on the political econ- omy of the country, covering the political systems, the legal systems, the insti- tutional frameworks, their economic performance, and their governance struc- tures, and the results achieved. The insights gained in the process are reflected in the country chapters and the concluding chapter. We wish to emphasize that the economic and other data and other presented in the country chapters reflect what was available at the time of the country visits. No attempt has been made to update this information, as the focus of the study is on binding constraints, using available data to support the arguments made. A large number of references have been cited. However, we take responsibility for any errors that remain. Ron Duncan Hilarian Codippily ACKNOWLEDGEMENTS We owe a great debt of gratitude to a number of institutions and people for their assistance in completing this study. First and foremost, our sincere thanks are due to AusAID for their sponsorship and financial support for the study, under the Australian Development Research Awards (ADRA). The University of South Pacific in Suva,