THE IMPLICATIONS FOR THE BAHAMAS
OF PARTICIPATION
IN THE CARICOM SINGLE MARKET AND ECONOMY

Prof. Bishnodat Persaud                        Dr. Michael Davenport
London, June 2000

Contents

Contents (cont'd)

ANNEX A Methodology used in comparing the CET and The Bahamian tariff 47 ANNEX B                Estimation of trade creation and trade diversion            49

Appendix A Terms of Reference

Appendix B The Bahamas Membership in Caribbean Inter-Governmental Agencies

Appendix C Itinerary and Persons Interviewed Appendix D Abbreviations Appendix E Acknowledgements

Executive Summary

The Bahamas is a member of the Caribbean Community but not the Common Market and it has not sought membership of the CARICOM Single Market and Economy (CSME), the establishment of which is nearing completion.

The Bahamas is an upper middle-income country with a higher per capita GDP than other members of CARICOM. This creditable economic performance is attributed to the particular tax structure, a concentration on tourism and off-shore finance and the early development of a large freeport in Grand Bahama.

Even for a small island economy, The Bahamas is unusually dependent on services exports for export earnings and employment. The two dominant service sectors contribute the greater part of gross domestic product and employment. There is now a significant expansion and diversification of the service sector through the opening of a major container transhipment facility and the construction of a large cruise ship-care facility in Freeport. Production of manufactures is very small, with almost all manufactured goods and large proportions of agricultural products and raw materials imported, predominantly from the United States. Export manufacturing is mainly confined to a few products from Freeport.

The different economic structure, a large dependence on import duties and minimal level of trade with other CARICOM members made non-participation in the Common Market and the evolving CSME understandable.

However circumstances are changing. The Bahamas is participating in the negotiations to form a Free Trade Area of the Americas by 2005. Participation in the WTO is becoming inevitable because of the many issues in its widened agenda, which is of direct interest to The Bahamas.

Joining the CARICOM Single Market and Economy cannot be considered in isolation of  participation in other regional and international trading arrangements such as the Free Trade Area of the Americas and the WTO's multilateral trading system. There are strong linkages in all these arrangements and the one with perhaps the severest implications for the Bahamian economy, the FTAA, is already in the process of negotiation.

Underlying all these linkages are globalisation, increasing technological connectedness and international economic and policy changes, which necessitate enlarging involvement of all countries in the international economic system. and `new economy' sectors. The service and merchandise exports of The Bahamas are affected by these changes and

policies, and unless The Bahamas participates in these regional and international arrangements, vital interests could be threatened and opportunities to benefit from them could be lost. Arrangements under the WTO such as the GATS, Trade Related Investments Measures, Technical Standards and Disputes Settlement are all areas in which The Bahamas has a strong interest. Even bank secrecy laws on which The Bahamas model of development greatly depends may face demands for modification. The Bahamas should therefore be in the WTO and join with other small, like-minded and regional partners to strengthen the pursuit of common interests.

Joining the WTO would require taking on international obligations, rules and disciplines. The Bahamas would need to get its special case fully understood. It depends on import duties and stamp taxes for 58% of its tax revenues and there would be pressure to treat both of these taxes in an amalgamated way and to lower them.

A shift to other taxes would be required and a VAT is regarded as preferable. But these adjustments carry greater administrative (and perhaps political) implications than economic ones. They imply no increase in the tax burden and only minor shifts in the distribution of this burden. They pose no significant constraint to the use of economic policy to benefit The Bahamas. In fact they provide some opportunities to further encourage international competitiveness and efficiency. But most of all, they do not require a change in the basic model of development, since they do not necessitate a return to income taxes. Thus point needs emphasis.

The negotiation process to join the WTO is a long one. It could take 4 to 5 years. This does not however entail a delay in Bahamian participation in the multilateral trading system. Upon application for accession to the WTO, observer status could be obtained which, with a clear intention to join, would ensure involvement in the WTO process including participation in sector negotiations, as well as, any new WTO Trade Round that might be initiated, and entitlement to technical assistance.

While these benefits would be immediate, the obligations, some of which would not be palatable, will need a long period for preparation and for implementation. Over time policies such as sector reservation for domestic investors, or exclusive rights to undertake particular economic activities, would have to be phased out. In some areas, though, for example services, the WTO is only now moving from framework rules to specific sectoral regulation_ It has begun to make significant progress in a few areas e.g. telecommunications, which would have near term implications for The Bahamas.

If The Bahamas decides to join the WTO and the CSME, it might consider starting the two processes concurrently and, because of the long WTO process, join the CSME earlier. This might be helpful to the WTO negotiation, since it would not only assist The Bahamas on its way to becoming WTO-consistent, but also help to secure better WTO conditions. The phased process of adopting the CET and the other CSMI obligations would indicate commitment to moving in the direction of WTO consistency and obviate stringent immediate demands, especially as regards tariff reduction.

Trade with other CARICOM member states is very small. Less than '/z per cent of merchandise exports go to the CARICOM countries and other countries which have preferential trade arrangements with CARICOM - the Dominican Republic, Haiti, Venezuela and Colombia - and could become members off the common market at a future date. About 1 per cent of the re-exports of the Bahamas go to this group, which for shorthand purposes we refer to as CARICOM Plus, while just over 1/2 per cent of Bahamian imports come from CARICOM Plus. Under these circumstances the direct economic from joining a customs union will be small, since trade creation is positively related to the share on imports coming from the existing members. On the other hand trade diversion, which means that imports will be resourced to suppliers within the customs union from lower cost producers outside, will be relatively larger_ However trade diversion net of trade creation would have reached only 0.4 per cent of The Bahamas' total imports in 1997, taking the largest of three alternative sets of estimates.

There will be other economic effects from joining the CARICOM common market, but given The Bahamas' small manufacturing base, from a macro-economic point of view, these too will be small. However the loss in protection afforded to the manufacturing sector will be significant for those who work in it. A large number of small firms would likely close unless other ways of supporting them were put into effect.

The Bahamian government relies heavily on tariffs and taxes on imports as sources of revenue. Since the CARICOM common external tariff averages some 11 per cent against an average charge on Bahamian imports of some 36 %z per cent, the impact of switching to the CET would be serious as regards government revenues. Presumably if The Bahamas switches to the CET, a 5-year transition period will be agreed as it was for the other CARICOM member countries. During this period the government will presumably have to introduce some new tax instrument to offset the 15 to 16 per cent loss in revenue. It was suggested to us in The Bahamas that this would probably be a Value Added Tax and of alternative indirect tax systems, this is indeed the least distortionary and relatively transparent and easy to administer. A VAT has indeed been adopted by a number of CARICOM countries. Nevertheless a lot of decisions would have to be made about coverage, for example whether capital goods or tourist and financial services be exempted, and about whether there would be a single or multiple rates, either in the interests of particular producer groups or low income groups. Any special tax regimes would have to be examined to ensure that they were not only CSME-consistent but also WTO-consistent, if it were decided to press ahead with WTO membership.

Phasing in rights of establishment and freer trade under the CSME would enable The Bahamas to begin to accept limited foreign participation in the reserved areas and increased exposure to international competition in a way, which would help in preparing for wider participation, and competition, which The Bahamas would have to allow eventually under the WTO and the FTAA. In any case, in areas such as the rights of establishment and the removal of restrictions on capital movements, Protocol 2 only calls at this stage for a stand still and for beginning a process of liberalisation, obligations which are not difficult for The Bahamas to accept and in some areas like capital movement could be beneficial for The Bahamas. Moreover, joining would mean active participation in the negotiations to roll back restrictions, which The Bahamas would be in a position to influence, and in some areas, to obtain special treatment, taking into account its particular circumstances. An early decision by The Bahamas or an early indication to CARICOM of a serious intent to have a closer involvement in the CSME would enable active participation and influence in the negotiations on detailed programmes of liberalisation, which have begun.

On the movement of people, Protocol 2 liberalises movement for the self-employed and of managerial and supervisory personnel necessary in the establishment of businesses. Here too the call is for a stand still and for a process of negotiations on the modalities. The programme of liberalisation calls for priorities e.g. sectors which are foreign exchange earning. Such controls would help to avoid disruption for countries like The Bahamas where inward movement of the self-employed such as small service providers could cause undue displacement in previously reserved sectors. These obligations should not pose significant difficulties, and the course of the negotiations could be influenced by The Bahamas.

Not included in Protocol 2, but an obligation nevertheless arising from the spirit of the CSME and its objective of the free movement of the factors of production, is the agreed CARICOM policy on free movement for^- certain categories of workers - university graduates, artists, and media workers. The abolition of work permits in these areas could pose a difficulty for The Bahamas.

The high levels of remuneration in The Bahamas and its small size relative to the whole of CARICOM could make for disruptive penetration levels. And in the context of already large numbers of migrants, including illegal ones, in The Bahamas, they could pose special political difficulties, even though The Bahamas economy would continue to benefit from the importation of graduates and other highly skilled, trained and creative people. However The Bahamas already accepts more workers from other CARICOM countries than any other CARICOM member, and this trend would no doubt continue because of the buoyancy of its economy and its good prospects. In the circumstances, The Bahamas might be able to obtain a special regime for the movement of these categories, which could allow delayed implementation or complete derogation with a commitment for The Bahamas to use best efforts. This exception should not be seen by others as a precedent, in recognition of the reality of a continuing liberal and preferential policy for the employment of CARICOM nationals in The Bahamas.

One way of taking into account the special constraints The Bahamas might face in some areas is to provide recognition in relevant Protocols off its circumstances, as is the case with the Less Developed Countries and leave scope for waivers and other concessions. The justification for this would not he underdevelopment, but the difficulties that arise from special circumstances and economic structure and the advantage that would accrue to all members from enlargement of the CSME and full participation of The Bahamas in CARICOM. Such concessions would he required on a very limited basis, although in some areas like the movement of people, they could be significant.

This would seem a preferred way of accommodating The Bahamas in the CSME and encouraging its full participation. If however the constraints are deemed too large and too difficult to accommodate, the possibility might be explored of an `associate membership' of the CSME. This could take the form of a special agreement, which would specify areas of the CSME in which The Bahamas could participate. The latter has the advantage that it could include some areas from Protocols e.g. Protocol II, which The Bahamas may not be able to accept in its entirety or legally to sign.

This arrangement would also provide flexibility, which could allow widening participation in the CSME. This option would be better than continuing non­participation, which might be too inflexible, legally and otherwise, to allow the more complex, selective and advancing relationship that might be possible and that The Bahamas might prefer.

The Bahamas participates in the regional capital market discussions although, not being a signatory to Protocol 2 it does not participate in the programme of liberalisation of capital movement. Although it has exchange control, its macro-economic and reserves situation is of such that it is in a better position to take on the liberalisation requirements intended by Protocol 2 in this area. Taking on the CSME obligations poses therefore no significant problem and has advantages in that it is likely to be a net recipient of capital flows because of its stable currency and its special. tax status. Moreover, this would extend the range of investment opportunities for Bahamians and ^Bahamian businesses that are restricted now by exchange control regulations and by having to pay a premium for access to foreign exchange for investment abroad- Liberalisation could help The Bahamas to become a financial centre for the region in that its tax status could encourage finance institutions such as mutual funds, insurance companies and banks to locate in The Bahamas and do business regionally. The FTAA might even widen the regional scope for this. CARICOM also provides for regional currency convertibility, although not as part of the CSME. The Bahamas participates in this arrangement.

In relation to capital market development, participation in regional discussions takes place. And this is helpful to The Bahamas because it also needs to develop its capital market. The Bahamas has recently set up a Stock Exchange and it has provided for a central securities depository, which could facilitate regional stock-trading in future.

The Bahamas takes part in regional discussions on macro-economic stability and convergence, although it is not part of the process of establishing a Caribbean Monetary Union. This would continue to be beneficial in helping to develop domestic and regional means of self-discipline and increase capacity for regional co-operation. The Bahamas already meets the criteria for proceeding to join a CMU when this is established. However progress is slow and a target date for the CMU does not now exist. A constraint to early participation in such a Union is its strong commitment to its traditional arrangement of a one-to-one relationship to the US dollar. The setting up of the CMU is not imminent and with time and with increasing orientation in the region to trading with North America, pegging to the US dollar or endeavouring to obtain a stable relationshipwith it, may become the norm and this could make entry of The Bahamas in the CMU a less difficult proposition.

In joining the CSME, The Bahamas would have the opportunity to influence decisions on the form of the CMU and the pace of its adoption. In any case participation in the Caribbean Monetary Authority is not an imperative for participation in the CSME.

On the whole then, even though the model of development has been different in The Bahamas and this has been a constraint in participation in the CSME, this exploration concludes that this should not now be seen as a constraint. Such participation would not endanger growth and development in The Bahamas. The study is also very positive on WTO participation, both of which are critically linked in terms of requirements and the opportunities they provide. The Bahamas already has a. large involvement in international trade and finance and for this to be maintained and extended, joining the CSME and the WTO could be very helpful. However the adjustments and legislative requirements would be significant and The Bahamas must begin preparations and the negotiating processes early. The basic infrastructure for this involvement exists. It would need reinforcement and technical support.

THE IMPLICATIONS FOR THE BAHAMAS OF PARTICIPATION IN THE CARICOM SINGLE MARKET AND ECONOMY 1.      Background

The Bahamas acceded to the Treaty of Chaguaramas in July 1983 under a special arrangement, which allowed it to become a member of the Caribbean Community (CARICOM) but not of the Common Market. This arrangement was no doubt necessitated by a long-standing development policy thrust in The Bahamas, which utilised a special tax regime - exclusion of income taxes - and a consequent large reliance on indirect taxes such as import duties and stamp taxes.

This fiscal policy is regarded in The Bahamas as a major contributor to economic success. At current per capita GDP of over US$10,000 - the highest in the Commonwealth Caribbean - The Bahamas has long reached upper middle-income status. After a depressed period in the early 1990's, it is currently enjoying an investment and economic boom, with the economy growing at about 6% in 1999.

The perceived success of this tax structure, and the different economic model implicit within it, made it difficult for The Bahamas to participate in free trade with other CARICOM members and to adopt with them a Common External Tariff (CET). This consideration, together with a low level of trade relationship with CARICOM members for geographical and historic reasons, made non-participation in the Common Market understandable in the circumstances.

Nevertheless participation in other regional Caribbean economic arrangements and activities were not precluded. It could be said that The Bahamas sought maximum regional cooperation compatible with its non-participation in the Common Market.

The CARICOM has been deepening its economic integration and since the early 1990s has been advancing from the Common Market to the establishment of a CARICOM Single Market and Economy (CSME). That process is now nearing completion. Since The Bahamas was not a member of the Common Market, it was not part of this process. However it participates in the discussions, since these mainly take place in forums which are general to CARICOM, and not specific to the CSME. And in some areas such as regional capital market development, currency convertibility and macro-economic convergence, it participates not only in the discussions, but also in the practical arrangements which result e.g. currency convertibility.

When account is taken of involvement in CARICOM associated and other regional arrangements e.g. The Caribbean Development Bank (CDB), The Association of Caribbean States (ACS), The Caribbean Export Development Agency, The CARICOM Regional Negotiating Machinery and others (Appendix B), The Bahamas' participation in regional cooperation is not as limited as it would appear from its non participation of the Common Market and the CSME.

The context in which The Bahamas sought to be excluded from the Common Market in 1983 is now changing. Globalisation is proceeding apace aided by technological change, tradc liberalisation and the opening up of money and capital markets. The WTO has a trade liberalisation mandate which is much wider than that under the GATT. And regional economic cooperation and integration is advancing in all regions of the world and is increasingly being seen as supportive of, rather than counter-productive to, global

liberalisation.

In these circumstances, following a decision of the Summit of the Americas which took place in December 1994, all Western Hemisphere countries including The Bahamas, but with the exception of Cuba, are now engaged in negotiations to set up, by 2005, a Free Trade Area of the Americas (FTAA).

In the CARICOM region, economic change has narrowed the economic differentiation between The Bahamas and other CARICOM members. In nearly all the countries tourism has emerged as a major industry. Other countries, like The Bahamas, now offer off-shore financial services. Many are placing increasing reliance on indirect taxes.

In The Bahamas itself, economic development is furthering export orientation and international exposure, especially in relation to services. In the context of the wide mandate of the WTO in relation to trade in goods, services, trade related investment measures, trade related intellectual property rights and technical standards, it is becoming difficult indeed for any country with an economy as open as The Bahamas to remain isolated from the policy-making, legislative and dispute settlement processes of the WTO.

Against this background, the Government of The Bahamas advised the CARICOM Secretariat in 1998 that in preparing 1998 for participation in the hemispheric free trade area, it was also willing to re-examine its overall position with regard to membership of the Caribbean Community, and in particular its relationship with the CSME. The Bahamas is also in the process of preparing for accession to the WTO.

It was against this background that in consultation with The Bahamas Government, this study was organised and commissioned by the CARICOM Secretariat. The Terms of Reference, which influenced the format of the study, are given in Appendix A.

2.          Linkages - WTO, CSME and FTAA

The Terms of Reference require an assessment of the critical changes, including institutional changes, which The Bahamas will have to make to obtain WTO membership. This assessment is undertaken in the context of the major concern of the study, i.e. the participation of The Bahamas in the CSME, which is explored in later sections.

The inter-relationships between participation in the CSME, the WTO and the FTAA are strong. Although the implications of joining the FTAA are major for The Bahamas, especially in the context of its large dependence on import duties and of the US as a major source of its imports, there is an expectation in The Bahamas and in the region, that The Bahamas would not wish to seek isolation from the FTAA. The Bahamas has committed itself to the idea and process of establishing the FTAA.

Participation in the FTAA negotiations and the recent decision to explore the possibility of WTO membership, and to revisit the issue of the CSME should be seen not just in the context of their inter-relationships. Underlying them are globalisation and changes in the world economy and international economic policies, which make it problematic for The Bahamas to continue to make economic strides without adapting its development model to take into account these international changes. In fact if The Bahamas were not to attempt to anticipate, adjust to, and where appropriate, influence international developments that affect it, then changes would be forced on The Bahamas in due course, which could cause serious adjustment problems. A pertinent issue here is the current threat to its tax-exempt financial sector.

A relevant consideration is the need to make maximum efforts to increase participation in the world's `new economy.' The ability to grasp new opportunities arising from world economic changes and to ensure that its existing industries improve their competitiveness and efficiency, would indicate the need for greater interaction with the global economy, and for deeper involvement with regional trading arrangements. The Bahamas has a large dependence on international trade. Although its reliance on service exports is well recognised, it has also a substantial dependence on merchandise exports - crawfish, fish and other crustacean, salt, rum, and manufactured goods - $230m in 1997, ranking third among CARICOM countries in this sector.

in the WTO, developments already taking place or anticipated have important implications for The Bahamas. The Bahamas is largely a service economy and services have become an active area of negotiations in the WTO through the establishment in 1995 of the General Agreement on Services (CATS). This was largely a framework agreement, prescribing general principles and rules that would govern an international trading regime in services. Since its establishment, substantial progress has been made in developing more specific regimes for the telecommunications and financial sectors_ Wider negotiations on services will resume soon and will be active in the near future. It will be important for The Bahamas not to be excluded from these. Offshore financial services and bank secrecy laws could all come under the purview of the GATS, especially in the context of current concerns about harmful tax competition, money laundering and the major countries emphasis on transparency, in order to have access to information which could help them to track down the tax evasion and money laundering activities of their nationals.

Even were The Bahamas to stay out of the WTO, its exports would be affected by the latter's sanitary and phytosanitary regulations, food handling regulations, (this is already happening) environmental regulations, standards, regulations on. telecommunications and e-commerce and prescriptions on intellectual property rights. For the latter, sanctions could be imposed were The Bahamas not to respect international rules on patents and copyright. And where action in any of these areas is taken against exports from The Bahamas, there would be no recourse to the rules of the WTO or its disputes settlement mechanism, which have the potential to become very helpful to small countries, which, like The Bahamas, do not have clout in the international system and could therefore benefit from a rule-based system.

Presently The Bahamas derive benefits from the Lome Convention (which has now been superseded by a new Agreement), the Caribbean Basin Initiative (CBI) and the CARICOM/Canada Trade Cooperation Agreement (CARIBCAN). Under the Lome Convention, substantial benefits accrue from the exports of rum, a product for which valuable trademarks are held, which could greatly benefit from WTO's International Property Rights protection_ Preferences granted by the US under the CBI have recently been extended to remove erosion entailed by NAFTA. This would provide additional export opportunities for The Bahamas.

The issue of joining the CSME is considerably influenced by considerations of WTO and FTAA membership. Joining either the CSME or the WTO would make the other an easier and more consistent process. If a persuasive case exists for WTO and FTAA membership, then constraints to CSME membership largely disappear since the obligations are mainly similar. In the case of the FTAA, the constraints are even more severe for The Bahamas since the objective is a free trade area which could mean, depending on the regime allowed for small countries, a large or complete shift from import duties and stamp taxes which now provide the major share of the government's revenue (about 58 per cent -