Economic Insights: The IMF Assessment of the Economy of Dominica: Part II

We continue to bring you, our readers, the main points of the most recent International Monetary Fund (IMF, also referred to as the Fund) reviews of the economy of Dominica. These are the IMF Country Report No. 17/392: Dominica Selected Issues prepared in April 2017 and published in December 2017and Staff Report for the 2018 Article IV Consultation (Country Report No. 18/265) published on 30 May 2018.

Part II focuses on economic growth

Economic Growth

How does Dominica compare with others?

The growth of output of goods and services (Gross Domestic Product or GDP, for short) in Dominica lagged behind growth in emerging markets and developing economies (EMDE) in the period 1980-2015. During that period, the economy of Dominica grew at an average of 2.7 per cent per year, below the 3.3 per cent of the Eastern Caribbean Currency Union (ECCU) and 4.5 per cent in EMDEs.

The Country Report No. 17/392 confirms that Dominica's best period of economic activity was the 1908s, with growth exceeding 5 per cent which was similar in performance to the rest of the ECCU. The divergence from the rest of the Currency Union and the EMDEs started at the beginning of the 1990s and intensified in the aftermath of the Global Financial Crisis of 2008-2009. While growth has been stagnating in Dominica since the start of the global crisis, the world economy has grown by 5.3 per cent and that of the EMDEs by 10.6 per cent over the period 2009-2015.

Factors Limiting Economic Growth in Dominica

•Falling population and very high outward migration of skilled persons

While population in Dominica decreased between 1980 and 2014, it increased significantly in other ECCU countries. In Dominica, the population declined by 5.5 per cent during the period. In places like St. Kitts and Nevis and Antigua and Barbuda, the population grew by more than 20 per cent. Grenada recorded an increase of 17.6 per cent. The decline was mostly driven by outward migration that the Fund has described as sizeable. A high proportion of that outflow was the more educated citizens. In fact, the emigration rate for high skilled persons is an unbelievably 80 per cent. In other words, four out of every five highly skilled Dominicans leave the island for better pastures. Because of this significant exodus, the contribution of population to growth was close to zero.

•Low proportion of the working-age population that is employed

The proportion that is employed in Dominica is only 30 per cent, the lowest in the ECCU and well below the 45 per cent for the Latin America and Caribbean region. Of that 30 per cent, the public sector accounts for around 20 per cent.

•Inefficient and low levels of investment

Taking a long term historical view, the Fund estimates that government's investment in physical stock (roads, bridges, ports, etc.) averaged around 22 per cent of GDP between 1970 and 2014. This is the lowest in the ECCU and appears relatively low in comparison to the rest of the world. The returns or outputs from the investments are also of concern. They are not high, and this is so for a variety of reasons including the damages wrought by natural disasters, capacity constraints in public administration (leading to low implementation) and very limited impacts on private sector investment.

Productivity

The Fund staff developed a framework to account for output growth in Dominica. The result of their modelling, which incorporated the impact of natural disasters, showed that the efficiency and intensity of the use of inputs to produce goods and services―the level of overall productivity or what economists refer to as the Total Factor Productivity (TFP) — is the main determinant of growth. It has been continuously declining (except for the 1980s and a temporary uptick in the period before the Global Financial Crisis). It is not surprising therefore that the historical deceleration in growth was mostly driven by the declining contribution of TFP.

Looking specifically at labour productivity, the Fund found that the growth rate of wages has been higher than that of output per worker. This disconnect explains the concentration of labour in the economic sectors with relatively lower productivity. For example, 25 per cent of total employees work in public administration, which is among the least productive sectors.

The implications for future growth

What does all this mean for the prospects of the economy? The Fund's conclusion in April 2017 was that, without meaningful policy changes that affect investment and labour allocation, potential growth in Dominica will remain disappointing. At that time, it estimated growth to be in the range of 0.2-2.6 per cent, slightly below 1.5-2.5 per cent in the ECCU. If the trends in TFP observed after the Global Financial Crisis continues, growth will be closer to the lower end of the range.

Reviewing the Dominican economy in the aftermath of Hurricane Maria in May 2018 and before the re-location of Ross School of Medicine to Barbados, the IMF, in the 2018 Article IV Report, estimated that output of goods and services declined by 4.7 per cent in 2017 and projected a further reduction of 14.1 per cent in 2018. Output is forecast to return to pre-hurricane levels in five years but it could take longer.

The impact of the Hurricane Maria presents Dominica, in the words of the Fund, with severe sustainability challenges, compounded by systemic financial risk. These include:

•Significant deterioration in government finances characterized by increases in the budget deficits in 2018-2021; decline in tax revenue; increased debt, projected to rise to approximately 90 per cent of GDP in 2018 and remain at that level in the coming years from 72 per cent in 2016; and the unpredictability of CBI inflows. The Fund states that these will put the country in tight financial constraints and unable to sustain adequate investments to grow the economy;

•Supply constraints (shortage of skilled workers and construction materials for reconstruction);

•Inadequate insurance coverage of the private sector. For example, only 30 per cent of the housing stock is insured;

•Slow payouts by insurance companies. At the time of the IMF visit in April 2018, 33 per cent of claims (equivalent to 15 per cent of GDP) were still outstanding;

•Undercapitalization of some major financial institutions; and

•High non-performing loans (17.4 per cent of loan portfolio for banks).

Recommendations:

The IMF recommends that the government consider the following actions to boost growth and improve the stability of the financial sector:

•Adopt labour market policies that influence migration and labour allocations across sectors. For example, the government could implement training to facilitate people in obtaining the requisite skills to move to areas where there is a demand for labour and to improve productivity;

•Consider the impact on the overall economy when deciding on public wage increases;

•Undertake investment and the enactment of regulations to improve resilience of public and private infrastructure to natural disasters;

•Adopt cost-effective fiscal policies that contain the accumulation of debt while supporting the recovery efforts;

•Remove barriers to private sector investment and profitability;

•Implement stronger regulation and supervision and a crisis management plan for non-bank financial institutions; and

•Take decisive measures to resolve non-performing loans.