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Trinidad & Tobago has not maximized large foreign investment received - World Bank paper

World Bank, Economic Premise May 2014, Number 142
A Future without Oil? Diversifying Options for Trinidad and Tobago
By Francisco Galrao Carneiro, Rohan Longmore, Marta Riveira Cazorla, and Pascal Jaupart

Trinidad and Tobago (T&T) is an example of successful diversification within the oil and gas sector and the country is now a global player in the energy industry. Diversifying its asset base so that the nonresource sector can continue to grow and generate jobs once the country’s oil reserves are depleted is also an important priority for Trinidadians. With reserves of oil and gas in T&T expected to be exhausted by 2025–30, the government is focusing more and more on options for diversification. Although many countries have grown and improved their development outcomes while remaining highly dependent on natural resource rents, the obvious concern is what will be the sources of growth for the country when oil runs out? In this context, this note identifies the binding constraints and potential drivers to further economic diversification in T&T.

Why Is Diversification Important for T&T?

T&T can be characterized as a dual economy. With a gross national income (GNI) per capita of US$14,710 in 2012, the country is a high-income country, rich in natural resources, with a well-developed globally competitive oil and gas industry. The nonenergy sector is relatively underdeveloped, attracting little investment and, to a significant extent, depends on government subsidies and transfers. T&T’s economy has also been historically quite volatile and particularly susceptible to commodity price shocks.

As with most natural resource rich economies, the issue of economic diversification has been extensively debated in T&T since the 1950s. This discussion has taken on a new sense of urgency given recent revelations that the country’s largest industry, the oil and gas industry (45 per cent of GDP), could disappear within 15 years unless new reserves are found. In conjunction with exploration efforts, the government has been aggressively pushing for answers to the question of how best to diversify the country's economic base.

There is evidence that vertical diversification has occurred within the energy sector. Oil production has been following a declining trend since the 1980s, and has been replaced by natural gas as the dominant activity in the energy sector (Figure 1). In addition, growth in production of petrochemicals has mirrored growth in the production of natural gas. T&T has become the world’s leading exporter of ammonia and methanol, which, along with urea, make up the main petrochemical products in the country.

While vertical diversification is welcome, the major question that confronts policy makers relates to the slow pace of horizontal diversification. More specifically, what could be the major impediments to further diversification in the country? Has T&T paid enough attention to the diversification of its asset base (that is, its human and physical capital) and its institutions? This note discusses the main determinants of export concentration in T&T and the significance of potential drivers of diversification away from the resource sector in the context of a country that has already successfully diversified vertically within the industry.

Download the full World Bank report: http://documentos.bancomundial.org/cu...dad-tobago

If you don't have time to read the full report, this writer's summary of the key ensuing points are as follows.

How diversified are T&T's exports?

T&T appears to have made significant progress in terms of diversification over the last three decades. The twin-island country has also rapidly transformed in terms of diversification relative to other countries with similar structural characteristics.

Who are T&T's comparators?


Has foreign direct investment contributed to greater export diversification in T&T?

T&T is characterized by relatively large and volatile capital inflows compared to other countries in the Latin America and Caribbean (LAC) region. FDI inflows averaged 6.6 per cent of GDP during 1988–2011, above the LAC average of 2.4 per cent of GDP over the same period. In the 1980s and 1990s, T&T was able to maintain its position as a top performer in terms of the amount of investments it was successful in attracting. In the 2000s, however, the number of countries showing very attractive profiles for FDI as well as the diversity of profitable sectors for FDI significantly increased. Additionally, FDI inflows in T&T were severely impacted in 2009 and 2010 by the global financial crisis.

FDI in T&T has been mostly concentrated in the energy sector, particularly in the oil sector first, and, at a later stage, in the natural gas projects following deregulation of the sector. This transition helped the economy to diversify its energy sector, but not the nonenergy sector (ECLAC 2003). Later, the country succeeded in attracting new investments in other sectors, but this only slightly expanded the numbers of economic sectors in the economy. Not having a developed nonenergy tradable sector will probably continue to limit future growth due to lack of externalities in production, lack of forward and backward links, shortages of learning by doing, and lack of entrepreneurship. Consequently, the country has taken measures to stimulate the non-resource-based economy.

Over the last decades, the government of T&T has taken numerous measures directly aimed at encouraging FDI inflows into the energy and nonenergy sectors. FDI was also implicitly considered a strategic means of diversification because it was believed FDI would also act as a source of revenue for investments in physical and human capital, which the country needed to support the development of other sectors. The economy maintained strong tax incentives (bilateral investment agreements, double taxation treaties, and reciprocal regulatory agencies arrangements) and supported the implementation of free trade zones (FTZs) to facilitate export diversification. The aim was to use these initiatives to overcome obstacles and distortions in the rest of the country and eventually generate forward links to the development of manufacturing industries outside the energy sector. The government has also tried to actively promote foreign investments and established the Trinidad and Tobago Country Branding and Investment Promotion in charge of the administration of existing industrial parks.

Given the high ratio of FDI to GDP in T&T, evidence of the lack of diversification outside the energy sector suggests that T&T has not been able to fully maximize the potential benefits of the large FDI it has received.

As Mohammed, Moya, and Sookram (2010) indicate, the additional benefits that a foreign investor can bring depend on whether that investor generates spillovers to the rest of the economy through employment, technology, or innovation. This, at the same time, is strongly associated with the type of activity of the investing company and how it connects to other producers. The findings of Mohammed, Moya, and Sookram (2010) also show that FTZs have stronger spillover effects in countries where the local technology can be complementary to the FDI, and weaker effects in countries with a wide technological gap.

This may be a partial explanation as to why FDI inflows have not substantially fostered diversification outside the energy sector in T&T. The country’s technological and human capital are indeed still below its potential outside of the oil and gas sectors. Linking FDI incentives to human and technological capital development, as well as finding various ways of engaging the domestic and foreign private sector in this mission, would enable T&T to better seize the benefits of FDI in terms of economic diversification.

CONCLUSIONS

T&T is successfully diversifying its energy sector. With this, the country has converged toward the world average level of export concentration for 1980–2011, and T&T is now known as a global player in the oil and gas industry, instead of being recognized solely as an oil-based economy. Nevertheless, further diversification away from the oil and gas sectors remains an important objective because it would reduce its economic vulnerability to commodity price shocks and help secure output growth for many years after the full depletion of the countries’ limited oil and gas resources.

Findings presented here suggest that T&T should aim to attract more FDI in the nonenergy sector and take measures to increase FDI-induced spillovers in the energy sector.



Based on the findings of the literature on FDI determinants, this could be achieved by participating more actively in regional trade agreement initiatives, because this would increase access to the international markets that its local and foreign producers enjoy. Improving the functioning of the domestic financial markets could also facilitate the creation of new business activities and generate employment opportunities.

While Trinidadian education is already recognized internationally for its good quality, there is scope to improve it further. Secondary and tertiary education as well as research and development are important for maximizing FDI’s full benefits, and the authorities may consider investing more in these domains. Expanding the knowledge base of the economy would facilitate the development of new activities and also make the country more attractive to foreign investors.

T&T’s technological capacity needs improvement. An additional challenge for the country would be to find a way for domestic and foreign private sector entrepreneurs to participate in this effort and also agree to transfer technological knowledge. Similarly, bilateral trade and investments treaties, as well as institutional reforms, are policy options the government of T&T could seize to help reduce the concentration of the country’s economy.

Finally, a resource-rich economy that diversifies its economic structure, its products, and its partners—and that becomes less reliant on its most abundant endowment—is also less sensitive to macroeconomic shocks transmitted through large fluctuations in commodity prices. And with resource extraction highly capital-intensive, diversification creates additional sources of employment for the labor force. Indeed, recent research (World Bank 2013) finds a positive association between rising economic diversification and rising per capita income for countries with per capita incomes of up to US$20,000. Beyond that level, economies tend to reconcentrate, though high-income countries do not reach the concentrations usually found in low-income countries.

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Has T&T Been Suffering from “Dutch Disease”?

In the case of T&T, it is not actually knowing whether the country has suffered from Dutch disease, but the extent to which the phenomenon has been harming the country’s development. Indeed, Mohammed, Moya, and Sookram (2010) claim that in T&T, Dutch disease is not a cyclical phenomenon, but a permanent characteristic of the economy, given the historical preponderance of oil and gas in total exports over the last three decades.

Artana et al (2007) argue that the Dutch disease phenomenon accounts for only some of the reasons why T&T has failed to significantly develop its nonenergy sector. Artana et al find several other factors that have limited the expansion of economic activities in line with the findings presented here. First, evidence shows that natural resource abundance has affected public policies. Fiscal policy has been rather pro-cyclical in past years, and even though prudent fiscal management mechanisms have been created lately, the credibility of the authorities has suffered, exacerbating the macroeconomic risk perceived by business leaders. Second, the unsatisfactory quality of education appears to be another binding constraint in their study. Insufficient innovation and technological readiness outside the energy sector are listed as further impediments. Infrastructure bottlenecks also constrain diversification. Lastly, the rising criminality observed in recent years also appears to discourage entrepreneurship.

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Acknowledgments
The authors would like to thank Bernard Drum, Norbert Fiess, Auguste Tano Kouame, Denis Medvedev, Friederike Koehler-Geib, Christine Richaud, Giorgio Valentini, Caro- line Vagneron, and Sophie Sirtaine.

About the Authors
Francisco Galrao Carneiro, Rohan Longomore, and Marta Riveira Cazorla are Lead Economic and Sector Leader, Economist and Consultant, respectively, in the Poverty Reduction and Economic Management Network of the World Bank’s Latin America and Caribbean Region. Pascal Jaupart is a PhD candidate in economics and geography at the London School of Economics.

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