14 U.S. Virgin Islands Industrial Ambitions In The Context of a Maturing Caribbean Basin Initiative

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U.S. Virgin Islands Industrial Ambitions In The Context of a Maturing Caribbean Basin Initiative

RICHARD MOORE*

During the Cancun summit of October 1981, President Reagan presented what he then called a fresh view of development stress- ing more than simply aid and government intervention. Cited as the "Caribbean Basin Economic Recovery Act," enacted into law on August 5, 1983, and implemented on Jan- uary 1, 1984, the Caribbean Basin Initiative (CBI) very quickly created great hope and expectation in the Basin's nation states. Mas- sive United States investment, accompanied by U.S. financed infrastructure development across a wide range of industries, was ex- pected to instantly achieve the CBI's stated purpose, "to promote economic revitalization and facilitate expansion of economic opportunity." In a word, to put everyone to work.

As is usually the case with such endeavors, the CBI became everything from an "Eco- nomic Holy Grail" for some, to an "Anemic Economic Pina Colada" to others, and a possible stalking horse for future foreign policy in Africa to still others.

After two full years of experience, a series of Congressional hearings on the program's effectiveness was recently held by a House Ways and Means Subcommittee. Frustration based upon a failure of commitment by the U.S., on the one hand, and unrealistic expectations on the other, dominated these evalua- tive discussions. As the program enters its m a t u r i n g phase, m u c h analysis has been focused on possible legislative and adminis- trative changes in order to make the CBI more effective. Another type of change, the one suggested here, aims to correct both an error of perception in identifying the pro-

*Office of the Governor of the Virgin Islands. Invited Address at the Twenty-First International Atlantic Eco- nomic Conference and the 1 nternational Health Econom- ics and Management Conference, April 15-20, 1986, St.

Thomas. Virgin Islands.

gram's catalyst and an error in executing the program's marketing objective, needs no legislation to implement.

The U.S. Virgin Islands, the region's high- est per capita income jurisdiction, has played an important role by generating demonstra- tion effects for its poorer island neighbors.

This implicit and subtle leadership role places both a burden and an opportunity on the V.I. community.

The U.S. Virgin Islands, an unincorpo- rated territory of the U.S. since 1917, has had a long history of adjustment to continually c h a n g i n g i n t e r n a t i o n a l e c o n o m i c forces.

O w n e r s h i p by a succession of E u r o p e a n powers, a long Danish era, from the late eighteenth to twentieth centuries, very quickly brought forth the islands' economic potential as a producer of sugar and as an important trading and transshipment center. Just as rapidly, widespread cultivation of beet sugar and the invention of steam power eroded this economic base towards the latter part of the nineteenth century.

During the 1950's the postwar environment of a devastated Europe, world travel experience by U.S. servicemen, rapidly rising real income, and pent up demand for leisure pre- cipitated the discovery of the Caribbean and the V.I. as the world class vacation destina- tion it has become.

The tourism industry, the territory's largest industry, has traditionally been identified as unstable, seasonal, and not necessarily dependable. But the facts are that since 1950, when the t e r r i t o r y first began advertising, the number of visitors has declined in only three individual years; t975, 1981, and 1982. The tourism industry has been the territory's most dependable industry, over the long haul.

As agriculture declined, the tourism industry and the territorial government became the primary employers and the deficiency of this

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MOORE: CARIBBEAN BASIN INITIATIVE 15

economic mix became problematic. Tourism demand, seasonal to begin with, is virtually dependent on U.S. mainland resident's dis- cretionary income and is highly elastic with respect to U.S. economic conditions.

Broadening the economic base through industrial diversification became the neces- sary and sufficient condition to ensure aggre- gate employment and expenditure stability, as well as to secure the territory's economic viability. Although tax incentive legislation to encourage business investment was first enacted in the V.I. as early as 1948, efforts to expand the economic base were renewed in earnest in 1975 with passage of the V.I.

Industrial Development Act, creating the V.I.

Industrial Development Commission (IDC).

Under this program, a corporation which invests substantial capital, employs residents (IDC requirements), and conducts the domi- nant proportion of its business in the V.I.

[Section 934(b) of the Internal Revenue Code, mirrored in the V.I.] is eligible for 100 percent exemption from real property, gross receipts and excise taxes, and a 90 percent subsidy on income taxes and customs duties.

The diversification of the territory's economic base has been enhanced by this incentive program. In recent years, it has been directly responsible for 25 percent of private, non-agricultural wage and salary employment, precipitating local first round expenditure and income tax revenue ranging from

$2.90 to $7.00 per $1.00 of income tax subsidy. Certainly a tax investment, not a tax expenditure.

It is appropriate that the Secretary of State is an economist; the CBI is economic and foreign policy at its best. An important and implicitly understood goal of the program is the protection of American security interests in the region by fostering political stability through economic growth. Critical elements of the original proposal aimed to decrease barriers to opportunities for growth. This was to be accomplished by: a one way free trade area (FTA) p r o g r a m to the U.S. that it still retains; an extension of the 10 percent

investment tax credit to U.S. investment, which withered to a deduction for tourist expenditures; and significant, though not ex- traordinary, increases in economic, scholar- ship, and administration of justice aid.

What is the result, thus far? Unfulfilled expectations on the one hand, as noted above, and more qualified promises on the other, have caused somewhat of a paradox. The Agency for International Development esti- mates over $200 million in investment has created over 35,000 jobs but U.S. imports from the region declined 23.1 percent between 1983 and 1985.

F T A covers a very broad range of products, b u t e x c l u d e s a p p a r e l , p e t r o l e u m , canned tuna, footwear, gloves, purses, lug- gage, flatwear, certain watch parts, and sugar.

Recent descriptive research has shown that of the top 30 most important U.S. imports from the region, nearly one-half are excluded, one- third have no duty anyway, 6 percent are G S P commodities, and about 7 percent are unaffected, l This leaves about 6 percent of existing exports positioned to take advantage of the F T A opportunity. However, the F T A program was established to develop non- traditional, currently non-existent exports.

The author will evaluate the significance of reduced U.S. tariffs on such commodities.

F o r two generations, tariffs have been de- clining in importance as a trade barrier.

Average U.S. tariff rates on dutiable commodities have declined from an average 28.2 percent level in 1945 to 5.5 percent today. In its place, non-tariff trade barriers have grown to limit market access and the F T A has no affect on these. The question boils down to whether or not high duty commodities, not otherwise exported from the region, could be profitably produced in the region.

But what of the 23.1 percent decline in e x p o r t s f r o m the region during 1983-85?

i i i i ii

1Craig Van Grasstek, Testimony betore the Subcommit- tee on Oversight, Committee on Ways and Means, U.S.

House of Representatives, February 25, 1986.

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16 ATLANTIC ECONOMIC JOURNAL

Almost all o f this was due to a d r o p in refined oil, alumina, and sugar f r o m the Bahamas, Netherland Antilles, Trinidad and T o b a g o , the Virgin Islands, and the Domini- can Republic. O f all the other beneficiary countries, only J a m a i c a and St. Kitts expe- rienced a d r o p in exports to the U.S.

In the East Caribbean, six of the eight countries more than doubled in their exports and the remainder increased, exports by an average 15 percent. During the same period, however, exports from the rest of the world to the U.S. increased 46 percent. C a r i b b e a n Basin export growth might well have been higher, relative to the rest of the world, except that the region was generally tied to an inflated dollar and had low export capacity in F T A commodities.

There are successes to observe in the CBI's trade story, thus far, and these are contained in the 3.1 percent proportion of tile region's exports to the U.S. These were eligible c o m - modities, not part of the GSP; were non- traditional export products; had a high export growth rate; and, otherwise, had a high duty.

Organic chemical products and c o m p o u n d s (primarily ethanol), iron, steel, and edible fruit concentrates r o u n d out this list. Al- t h o u g h hard data are not yet available, it is a p p a r e n t that a significant p r o p o r t i o n o f investment in productive capacity for these commodities originated outside the U.S. This is indicated by the fact that there is n o w pres- sure in the U.S. Congress to erect non-tariff trade barriers to protect domestic producers o f these commodities.

There are several lessons here, First, at best, one can observe a unique set o f non- traditional exports f r o m the region for which a p r o t e c t i o n i s t r e a c t i o n has o c c u r r e d . At worst, all non-traditional exports f r o m the region will have other tests to pass; the administration's goal to increase non-traditional exports is not shared by Congress and one is just becoming aware of this divergence.

The second lesson derives f r o m the first and reveals a central theme.

In M a r c h 1982, C o n g r e s s received the

President's C B I proposal which included a 10 percent investment tax credit as a means of attracting U.S. investment to the region. The investment tax credit withered to a vacation tax deduction for individuals, but a perception remained, that U.S. investment would dominate.

This was the first error. W i t h o u t the investment tax credit, access to the U.S. market alone was n o t sufficient to generate the antic- ipated rate of investment by U.S. firms. This error in perception created an opportunity for the resulting error in execution: The U.S.

D e p a r t m e n t of C o m m e r c e p r o m o t e d the CBI as if U.S. investment were critical for the program's success and has done little, thus far, to market the p r o g r a m in foreign countries.

A more appropriate perspective was recently noted by Vice President George Bush in remarks last N o v e m b e r to the Miami Con- ference on the Caribbean:

"... the private sector needs to make itself more aware of the opportunities in the Caribbean region. This includes the private sector outside the United States. CBI has never been and was never intended to be just for U.S. companies. Any investment from nationals of any country is wel- come, if it fits the CB1 criteria. Attracting investment to the region from other developed countries remains a high priority for the U.S. and, I expect, for everyone in- volved in the CBI."

This perspective represents a radical depar- ture and r e f o r m from the current approach, yet requires no federal legislation. T h e point is that the F T A p r o g r a m ' s objective (to generate non-traditional exports f r o m the region) and its circumstances (no U.S. investment tax credit) in theory will most clearly attract investment f r o m those most h u n g r y for U.S.

market access: individuals and corporations in foreign countries.

The current success stories reflect this hy- pothesized outcome. As an aside, these success story commodities are relatively technol- ogy intensive, so as to allow a higher proportion of domestic value added to be repatriated to the investing country.

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M O O R E : C A R I B B E A N B A S I N I N I T I A T I V E 17

Available circumstantial evidence indicates this error of perception and execution has limited the number and value of non-traditional exports from the region during the early years of the CBI. As it enters a maturing stage, reform is needed to align the program's results with its objectives. In the V.I., renewed efforts have begun to evaluate the relative industrial development return per scarce dollar spent promoting the territory to the U.S. versus the most developed of Latin American developing countries.

Since 1980, U.S. recession and recovery have taken a severe toll on the local economy due to high local elasticity to U.S. economic conditions and the export crippling strength of the dollar. Primary metals production and oil refining, observable in the V.I. with the Martin Marietta Alumina refinery and the Hess Oil Virgin Islands C o r p o r a t i o n oil refinery, were particularly hard hit and have little or no probability for improved market conditions in the near term. This is wholly due to the slow growth in demand from the recession's trough and vertical integration in production at raw materials sources in late developing countries.

As recently as 1981, these two firms em- ployed approximately 2,000 persons, nearly two thirds of all V.I. manufacturing employment or 10 percent of all jobs on St. Croix.

The Martin Marietta plant has closed and it has been estimated that a total of 1,000 jobs have been lost through direct and indirect means. This represents a total employment loss to St. Croix of 5.2 percent; a 21.2 percent decline in V.I. manufacturing employment; and 3.0 percent decline in total V.I.

employment.

In response to these economic circumstances and unstable federal grants and contribu- tions since 1979, the V.I. has explicitly chosen a self-help approach to assert greater local control of the territory's economic development through full utilization of available economic development tools.

T h e V.I. D e p a r t m e n t of C o m m e r c e , through the Industrial Development C o m - mission, has established the V.I. Light Indus- trial P a r k on St. Croix. It is a 24 acre industrial park with 32 building lots. The infrastructure placement phase and construction of a 30,000 square foot shell building will soon be completed. Nearly all available space in this building has been requested and there are sufficient additional space requests to have generated plans to consider construction of a second building. The park has the capacity to generate 2,500 jobs.

An important unknown at this time is tax reform. As one is well aware, the V.I. mirrors the U.S. Internal Revenue Code. The House and prospective Senate tax reform bills, taken together, include simplifications to the mirrored income tax system. These bills will apply "qualified domestic reciprocity" as a method of integration; provide for placing the V.I. under Section 936, as in Puerto Rico, to attract U.S. investment; and allow the V.I.

to use income tax forgiveness, along with a reduced withholding tax, to attract foreign investment to and through the V.I.

The V.I. perspective on CBI reform is to open up local industrial incentives, the territory's tax and physical infrastructure, as well as its industrial promotion program to attract foreign investment, in addition to U.S. investment. Reform of this type needs no federal legislation. It is also in line with the CBI's overall objective to reduce the region's geographic and infrastructural handicaps through enhanced alternative investment incentives.

The current F T A proposed restrictions in both the House trade bill and the Senate tax reform bill are essentially political questions and will resolve the efficacy of the region's unfulfilled expectations. The people of the Virgin Islands certainly presume that, with these reform measures under consideration, the current expression of unfulfilled expectations is simply misplaced.