What can be done to lower unemployment rates in the Caribbean?

Public policy

Caribbean countries are small open economies that have been subject to frequent external shocks. They are diverse in terms of resources-including commodity exporters and service-based economies with heavy reliance on tourism receipts and financial services. The common macroeconomic challenges faced by the various groups relate to their vulnerability to external shocks because of very high openness to international trade. In addition, Caribbean countries are highly exposed to natural disasters and except for resource-rich ones, are constrained by limited scope for stabilization policies, reflecting rigid exchange rate regimes and tight fiscal space to weather external shocks.

Countries in the region are mostly characterized by low growth and high debt. Despite the region-wide diversity in resources, individual country overreliance on a single resource, mainly tourism, has increased their vulnerability to external shocks. Moreover, because of limited fiscal resources, governments have pursued a pro-cyclical fiscal policy stance further exacerbating economic fluctuations. Many of these economies have resorted to extensive borrowing over the years in the face of external shocks that necessitated an increase in government spending, and thereby pushing debt ratios to levels that have posed increasing risks to debt sustainability. In 2012, overall public debt in the region was estimated at about 79 percent of regional GDP. Concerns about debt sustainability have weakened confidence and limited resource availability in support of private sector activity and economic diversification.

External shocks and high indebtedness in the Caribbean countries have hampered prospects for growth, increasing unemployment. Growth in the Caribbean has stagnated in the last two decades, except in the commodity exporters. The last episodes of rapid growth the region experienced were fueled by factors that are not attributed to domestic policies and/or structural reforms. Instead, growth fluctuated in response to commodity prices, tourism receipts, banana production, and external grants. Further, the job content of growth has been limited during economic booms, reflecting deep-rooted structural impediments that have left unemployment at high levels over time.

Failure to mobilize growth has taken a severe toll on the population of many Caribbean economies. Unemployment has fluctuated over time with cyclicality in real growth, resulting in severe loss of jobs during contractions and limited job creation, particularly in high value-added sectors of the economy during booms. The result has been slow growth of per capita income, rising unemployment rates, particularly among youth and women, increased vulnerability of large segments of the population to external shocks, and rising poverty.

Our investigation takes stock of conditions in the labor market to evaluate the association between employment and output growth and the prospect for job growth going forward. More specifically, the research agenda aims at providing answers to: (i) why the unemployment rate has been historically high across many countries in the Caribbean? and (ii) to what extent varying country experiences reflect domestic policies and structural rigidities?

Employment growth has varied with the business cycle in many countries in the Caribbean. Cyclicality in employment growth has reflected labor markets’ vulnerability to external shocks, given uncertainty and limited scope to apply timely countercyclical policies. Except for resource-rich countries in the region, cyclicality of growth has produced high unemployment rates during cyclical downturns and limited scope to mobilize employment during cyclical upturns. Productivity growth has remained stagnant, on average, attesting to failure to enhance productivity towards a more vigorous agenda of job creation.

The employment-output elasticity further attests the importance of growth to job creation and sustainable human development. In most countries, the magnitude of elasticity indicates close association between employment and output, except for resource rich countries where structural policies have targeted a reduction in unemployment over time, independently of the growth cycle.

Efforts to mobilize additional growth and job creation should take top priority going forward to reduce poverty and increase real per capita GDP in Caribbean countries. Capitalizing on historical employment-output elasticity, three scenarios are produced for prospective developments in the labor market. In the first scenario, medium-term projections estimate the unemployment rate, assuming baseline growth projections. Given limited scope to mobilize growth and create jobs, medium-term unemployment projections remain high in most countries. Two other hypothetical scenarios for growth are considered, capitalizing on historical employment-output elasticity. The second scenario calculates output growth rates that are necessary to stabilize the unemployment rate at its current level, i.e., create jobs to absorb new entrants to the market. The third scenario embarks on a more ambitious strategy to calculate growth rates necessary to reduce the unemployment rate by 50 percent. The upshot of this analysis warrants a comprehensive agenda that should be in place to mobilize growth and sustain lower unemployment rates over the medium term, given prevailing high unemployment in many countries of the Caribbean.

Estimates of structural coefficients indicate sharp variation in the transmission of growth to unemployment across Caribbean countries. As the figure shows, in Trinidad and Tobago, cyclical response of unemployment to the output gap is very low, reflecting an employment strategy which is highly dominated by public employment and has persistently pushed the unemployment rate downward independently of the growth cycle. In Jamaica, despite high cyclicality of employment with growth, the unemployment response has been low, reflecting low job content of growth, compared to growth of the labor force over time. In St. Lucia, the low unemployment response to the growth cycle reflects low formal job content of growth and high growth of the labor force, relative to formal employment. The larger response of employment/unemployment to the growth cycle in Barbados reflects relatively higher formal employment and better ability to create jobs in excess of new entrants to the labor market.

Figure 1:  Elasticity response of unemployment to growth

 Elasticity response of unemployment to growth

Domestic policies and structural reforms that support private investment should be at the core of job creation and growth enhancement strategy. The results of estimating empirical models identify important domestic and external determinants of employment over time and cyclicality in the short term. The menu of explanatory variables include domestic policy variables, government investment and private credit, and determinants of external performance - real effective exchange rate, prices of major exporting commodities, number of tourists, and growth in major trading partners. In general, government spending, private credit and/or improved competitiveness have helped support trend growth in employment over time. However, pro-cyclicality in government spending could be detrimental to job creation, because of crowding out of private activity and increased concerns about debt sustainability. Indeed, the evidence points to the importance of sustaining credit growth to the private sector to mobilize employment growth. Further, maintaining competitive real effective exchange rate helps the employment agenda, which is further supported by confidence boost surrounding episodes of high growth in major trading partners. In a pooled sample across the Caribbean over time, a boom in tourism has helped create jobs in support of cyclical growth of employment.

Structural and institutional impediments have constrained the scope to create jobs, even during episodes of high growth, and hampered success of domestic policies. To explain the empirical evidence and further shed light on necessary reforms, the paper takes stock of existing rules and regulations governing labor markets in a sample of Caribbean countries. Major challenges relate to youth unemployment, the mismatch between skills and jobs, low levels of labor productivity, and inadequate labor market information. To address these shortcomings, the structural reform agenda should embrace a vigorous agenda to close the mismatch between educational output and skill demand, target higher productivity through training and skill upgrade, promote social partnerships to strengthen labor market institutions, revise labor laws, and improve capacity and flexibility to boost competitiveness and reap the benefits of greater integration in the global economy. Addressing these shortcomings will help job creation to make growth more inclusive.

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