A REVENUE DIFFUSION FUND FOR THE.CARIBBEAN*

* Paper prepared f o r p r e s e n t a t i o n a t t h e Seventh Annual Conference

of thc Caribbean S t u d i e s A s s o c i a t i o n , May 25 - 29, 1982, Kingston, . .

Jamaica.

* * ~ a r i b b e a n Research I n s t i t u t e Col lege of t h e Vi rg in I s l a n d s S t . Cro ix , USVI 00840

I n t r o d u c t i o n

I n 1975-1976, t h e B r i t i s h Government l i t e r a l l y gave Dominica

a check t o main ta in i t s economy. Subsequent ly , t h e A n g u i l l i a n

government r e c e i v e d one q u a r t e r m i l l i o n d o l l a r s t o a s s i s t i t i n

i t s budgetary inadequac ies . More r e c e n t l y , i n A p r i l , 1982, t h e

Guyana Government p u b l i c l y noted t h a t i t was bankrupt . From r e c e n t

r e p o r t s , it i s a l l e d g e d t h a t t h e government of S t . Ki t ts -Nevis w i l l

be bankrupt by June, t h i s y e a r . These i l l u s t r a t i v e examples a r e

sympotmatic of t h e f i s c a l p rob lemstha t n e a r l y a l l of t h e Caribbean

c o u n t r i e s have been f a c i n g over t h e y e a r s . I n an e f f o r t t o come t o

g r i p s w i t h t h i s problem, we sugges t t h a t t h e Caribbean c o u n t r i e s

should implement a p l a n which we c a l l a Revenue D i f f u s i o n Fund (RDF).

1 The i d e a f o r t h i s Revenue D i f f r ~ s i o a Fund was f i r s t developed

i n a 1976 monograph (.Tones-Hendrickson, 1976). Another v e r s i o n of t h e ideawas i n c o r p o r a t e d i n a1379 book prepared f o r t h e Regional Monetary S t u d i e s Program; s e e Jones-Hendrickson (1979). Th i s t h i r d v e r s i o n o f t h e Revenue D i f f u s i o n Fund i n c o r p o r a t e s t h e s u b s t a n t i v e f e a t u r e s of t h e e a r l y d i s c ~ ~ s s i o n and expands on t h e model.

I n t h i s paper w e w i l l cover t h r ee a reas : i n s e c t i o n one we w i l l

o u t l i n e the RDF i n terms of the na tu re and need f o r the RDF; i n

s e c t i o n two the development and adminis t ra t ion of t h e RDF is d i s -

cussed, and i n s ec t i on th r ee a model is presented a s an i l l u s t r a -

t i o n of one approach t o t e s t i n g and implementing the RDF over t i m e .

I n the conclusion w e p resen t a politico-economic r a t i o n a l e f o r t he

need t o have an RDF i n the Caribbean.

I . OUTLINES OF THE REVENUE DIFFUSION (RDF)

A. Nature and Need:

W e view the Revenue Dif fus ion Fund (RDF) as a pool of money

from which Caribbean coun t r i e s can draw when they have budgetary

problems, and a fund t o rep lace e x t e r n a l borrowing, i n t h e long-

run. One way of understanding the na ture of the Fund i s t o s ee

i t a s a "partner-hand," i n terms of the Caribbean connotat ion,

o r a revenue-sharing arrangement i n terms of f i s c a l federal ism.

The RDF i s b e s t understood i n t he context of a f i s c a l system

wherein t h e r e a r e a c e n t r a l system and a l o c a l system. I n the

case of t h e Caribbean, t he RDF w i l l work b e s t i n a s i t u a t i o n

where f i s c a l r e s p o n s i b i l i t i e s r e s t both a t t h e o v e r a l l coordinat-

ing body, c a l l e d i t the Caribbean-Nation S t a t e (CNS), and a t the

l o c a l l e v e l , t he Island-Nation S t a t e (INS).

There is a s t rong p o l i t i c a l and economic r a t i o n a l e f o r

s t r u c t u r i n g the na ture of t he RDF on a Caribbean-Nation S t a t e

and Island-Nation S t a t e system. The r a t i o n a l e stems from our

eva lua t ion of t h e f i s c a l s t r u c t u r e s of t he var ious Caribbean

governments, and our ana lys i s of t he skewed resource bases of

the coun t r i e s , p r i n c i p a l l y t he Micros ta te Economies versus the

Macrostate Economies. Given t h i s skewness i n t he d i s t r i b u t i o n

of resources , among the coun t r i e s , and given the p o l i t i c a l need

f o r a Caribbean-Nation S t a t e (CNS) , w e be l i eve t h a t a f i s c a l

mechanism, such a s the RDF, which seeks t o minimize t h e r e g i o n ' s

f i s c a l inadequacies, ought t o be t r i e d .

Apart from the genera l need f o r the RDF t o be a multi-govern-

mental opera t ion , t he re a r e some s p e c i f i c needs a t tached t o i ts

neces s i t y . I f w e examine the publ ic s e c t o r e s t ima te s of any Carib-

bean country, w e a r e su re t o cliscover some ins tances of f i s c a l m i s -

management. P a r t of the mismanagement i s due t o inheren t problems

i n t h e system of f i s c a l a f f a i r s ; however, some of t h e problems a r e

due t o the low e f f o r t of t echnocra t s /bureaucra t s i n t h e i r manage--

ment of t h e a f f a i r s of t he s t a t e s . But t he re a r e a l s o e x t e r n a l

fo rces - imported i n f l a t i o n , f o r example - which coa lese wi th t he

i n t e r n a l f a c t o r s which impose severe cons t r a in s on the f i s c a l

systems of the governments.

A t any poin t i n time, t he re fo re , t he re w i l l be some su rp lus

country, f o r example Trinidad today, bu t i nva r i ab ly there w i l l

be many d e f i c i t count r ies . Object ively, t he RDF i s aimed a t

e s t a b l i s h i n g a pool of funds which could be d i f fu sed from su rp lus

coun t r i e s t o d e f i c i t coun t r i e s . While Trinidad is a s u r p l u s coun-

t r y today, t he re i s no guarantee t h a t i t w i l l be a su rp lus country

forever . Given the na tu re of economic r e a l i t y i n t h e reg ion , and

given the need f o r socioeconomic t ransformation of t h e economies,

we see t he RDF a s providing a p a r t i c a l s o l u t i o n t o minimizing the

budgetary problems of the region.

11. THE ESTABLISHMENT OF THE RDF

A. Development :

The Revenue Dif fus ion Fund (RDF) should be operated such

t h a t money is co l l ec t ed from t h e var ious Island-Nation S t a t e s

(INS) and placed i n t he pool of funds. Some f r a c t i o n of t he

INS'S l o c a l revenue w i l l be set a s ide each f i s c a l year for t h e

fund (one percent is d e s i r a b l e f r a c t i o n ) . The f r a c t i o n i s

negot iab le but should r e f l e c t t he arrangement t h a t p r e sen t ly

ob t a in s i n t he case of the coun t r i e s ' con t r ibu t ion t o r eg iona l

bodies. 2

2 We a r e aware of the problems t h a t the coun t r i e s have i n

making payments t o reg iona l agencies . I n t he case of the RDF t h e i r a b i l i t y w i l l be c l o s e l y r e l a t e d t o t h e i r bene f i t s .

A b i l i t y t o pay would be an i n t e g r a l p a r t of t he RDF i n

the f i r s t f i v e years . It is poss ib l e , t he re fo re , t h a t some f i s -

c a l l y s t rong coun t r i e s may have t o make an above average ( f o r the

group) con t r ibu t ion t o the RDF i n t he i n i t i a l f i v e year phase-in

period, a l l th ings being equal . Such con t r ibu t ions could be

viewed a s a s s i s t ance t o the f i s c a l l y weak coun t r i e s , and s e l f -

su f f i c i ency t o con t r ibu t ing coun t r i e s (when the t i m e comes t h a t

they have t o draw from the RDF).

B. Administration:

1. Running the RDF

We suggest t h a t a r e g i o n a l committe, comprised of i nd iv idua l s

from the Min i s t r i e s of Finance and t h e Cent ra l Banks, se rve a s

t he agency t o administer o r run the opera t ions of the RDF. Each

f i s c a l year the Island-Nation S t a t e s would be expected t o make

t h e i r con t r ibu t ions t o the RDF. The Regional committee (Revenue

Diffusion Fund Committee, (RDFC)) w i l l review the f i s c a l s t a t u s

of each country both f o r the required con t r ibu t ion and f o r possi-

b l e a s s i s t ance from the RDF. The day-to-day running of the RDF

should be the func t ion of an overs ight s e l e c t committee from the

Cent ra l Bankers of the RDFC.

The RDF w i l l d i f f e r from the s o c i a l "partner-hand" arrange-

ment i n t h a t :

(a) a surplus country will not have the automatic

right to get assistance from the fund;

(b) surplus funds, that is, funds minus assistance

to deficit countries and administrative costs,

will be actively invested in the region.

The term structure of the fund should be skewed more to short-iterm

than long-term. This would make funds easily available for al'l.

The RDFC should have the option of investing the surplus funds in

financial instruments of those regional governments which are fis-

cally strong.

2. Using the RDF:

Island-Nation States will be permitted to borrow money from

the RDF based on their population, "tax effort" and "need". For

our purposes, we define tax effort as the ratio of inland tax

re venue to Gross Domestic Product ; "need" is defined as export

to import ratio.

The money which an Island-Nation State receives from the

RDF will not be earmarked. There should be no time constraint

on the number of years a country may receive assistance from &e

RDF. When a country, an INS, receives assistance from the RDF

it would be subject to quarterly review by the RDFC. The country

would have to adhere to certain rules of fiscal management.

Thcse rules should be jointly agreed upon by all members of t8e

Caribbean-Nation S t a t e ' s M i n i s t e r s of Finance and C e n t r a l Bank

Governors.

3 . P e n a l t i e s f o r Misuse o f RDF:

P e n a l t i e s should be impose on INS f o r e x c e s s i v e use of t h e

RDF. Loans should be r e f i n a n c e d , b u t t h e s e l o a n s should be made

t o t h e INS on a " v a r i a b l e f i n a n c e r a t e (VFR) ." The VFR may o r

may n o t b e n e f i t t h e borrower o f funds from t h e RDF. Composite

Caribbean-Nation S t a t e r a t e of i n t e r e s t , and no t t h e London

In te rbank Bank Ra te , should be t h e g u i d e l i n e f o r de te rmin ing

t h e VFR f o r t h e borrowers from t h e RDF.

The RDF should d i f f e r from t h e p r e s e n t f i n a n c i a l a r range-

ments i n t h a t no i n t r a s t a t e arrangements should be p e r m i t t e d i n

e f f e c t u a t i n g borrowing from t h e fund. For example, a s u r p l u s

coun t ry should n o t be pe rmi t t ed t o be t h e s o l e decision-maker

i n d e c i d i n g t o lend t o a d e f i c i t coun t ry . The RDF should be

c a r e f u l l y s t r u c t u r e d . Individual-Nat ion S t a t e s may borrow from

t h e RDF, o u t s i d e of t h e i r normal a s s i s t a n c e . However, t h e INS

which r e q u e s t funds should g e t permiss ion from t h e RFDC. An

TNS which borrow o u t s i d e of t h e normal a s s i s t a n c e program w i l l

be charged a t a h igher r a t e than t h a t a p p l i c a b l e i n t h e normal

case . Such an INS must a l s o s u b j e c t i t s f i s c a l p o l i c i e s and

programs t o s c r u t i n y o f t h e Revenue Di f fus ion Fund Committe

through q u a r t e r l y e v a l u a t i o n s .

It would be s t r o n g l y discouraged f o r any INS t o l end funds

t o ano ther INS a t r a t e s which a r e i n compet i t ion w i t h t h e RDF

l e n d i n g rates. Any INS which v i o l a t e s t h i s r e g u l a t i o m should

be suspended from borrowing p r i v i l e g e s , and o r should be

pena l ized mone ta r i ly . The p e n a l t y should be t h e e q u i v a l e n t of

t h e d i f f e r e n c e between t h e normal RDF l end ing rate and t h e lend-

i n g r a t e o f t h e l e n d e r t o t h e borrower s t a t e (a r a t e d i f f e r e n -

t i a l p r i n c i p l e ) . Le t u s expand on t h i s pena l ty . I f s t a t e A

makes a l o a n t o s t a t e B, o u t s i d e of t h e RDF arrangements , s t a t e

A would be denied a c c e s s t o t h e RDF f o r some t ime o r a p e n a l t y

should be imposed whereby s t a t e A pays i n t o t h e RDF an amollnt

t h a t is e q u i v a l e n t t o t h e d i f f e r e n c e between t h e amount a t RDF

r a t e and t h e amount n e g o t i a t e d a t t h e s t a t e s A - B r a t e . For

ex,ample, i f Antigua borrows $60,000 from S t . K i t t s a t s i x per-

c e n t p e r annum and t h e RDF l end ing r a t e i s two p e r c e n t p e r

annum, S t . K i t t s would be requ i red t o pay t h e amount of $2,400

i n t o t h e KDF ($60,000 x 4%). I f , on the o t h e r hand, t h e

S t . R i t t s -Ant igua n e g o t i a t e d r a t e is one p e r c e n t pe r annum,

S t . K i t t s would be charged $600 ($60,00 x 1 Z ) . How could t h i s

concept of t h e RDF be p u t i n t o o p e r a t i o n ? I n s e c t i o n t h r e e we

p r e s e n t a model which is i l l u s t r a t i v e of one i~pproach t o t h e

implementation of t h e RDF.

111. THE REVENUE DIFFUSION FUND: A MODEL

A. Revenue t o be if fused:

Operat ional ly, the RDF i s b e s t viewed as a system of col- i

l e c t i v e s t a t e s , which we c a l l t he Caribbean-Nation S t a t e , pass-

ing (d i f fus ing) funds t o Individual-Nation S ta t e s . Let u s assume

t h a t the revenue t o be d i f fused f a l l s between to and tl, where

to is the minimum revenue and is s t r i c t l y pos i t i ve . Let r ( t )

represent t he number of i s l a n d s with revenue of t. Assume t h a t

t is continuous and s t r i c t l y p o s i t i v e between t and t In a 0 1'

continuous case, we can show the Caribbean Nation S t a t e wi th

revenue t o be d i f fused of t o r lower. This w i l l be:

and i n t he d i s c r e t e case , i t is:

The average amount of the revenue t o be d i f fused from the

Caribbean-Nation S t a t e where the t is the minimum revenue f o r

t he continuous case is:

3 The development of "need" i s s i m i l a r t o the development

of Revenue t o be d i f fused .

and for the discrete case, it is:

~(t) P ~ * ( t ) = C t r(t ) i i i

(2,l)

B. Formula For Diffusion of FundsfromCNS to INS

4 Formally, one formula which may be used as the basis for

the diffusion of funds from the Caribbean-Nation State (CNS)

to the Island-Nation State (INS) is the following (using the

discrete case) :

where R = the funds to be diffused from the Caribbean-Nation State to the Island-Nation State

G = the amount of revenue collected by the Revenue Diffusion Fund Comitte (one percent of local revenue) .

4 Our model expands on the revenue-sharing model of Musgrave

and Polinsky (1970). Here we have incorporated a "Need factor" which is a function of the export nature of Caribbean Countries. For discussions and amplifications of revenue-sharing models similar to Musgrave and Polinsky (1970) see Goetz (1967) and Pechman (1967).

P = the population in the Island-Nation State j. j

T = inland revenue of Island-Nation State j. j

Q = the Gross Domestic Product of Island-Nation j

State j.

N = export to import ratio for Island-Nation j

State j.

Let us rewrite equation (3.0) as follows:

* where Q = T/Q.

A given Is land-Nat ion S t a t e h a s s e v e r a l o p t i o n s opened t o

i t i n terms of what i t could do t o maximize t h e r e c e i p t of i t s

funds from t h e RDF. Le t u s c o n s i d e r t h r e e o p t i o n s :

(1) t h e r e c e i p t of money from t h e RDF r e l a t i v e

t o t h e amount of money c o l l e c t e d by t h e RDF;

(2 ) the r e c e i p t of money from t h e RDF r e l a t i v e

t o t h e i n l a n d revenue of t h e INS; and

( 3 ) t h e r e c e i p t of money from t h e RDF r e l a t i v e

t o t h e Gross Domestic P roduc t .

One i n t e r p r e t a t i o n of t h e t h r e e o p t i o n s could be a d e r i v a -

t

t i o n of t h r e e shor t - run " m u l t i p l i e r s " from e q u a t i o n (3 .0) . Thus,

f o r t h e t h r e e o p t i o n s , t h e t h r e e " m u l t i p l i e r s " w i l l be:

(1) t h e change i n t h e funds t o be d i f f u s e d t o

t h e INS r e l a t i v e t o t h e amount of money

c o l l e c t e d by t h e Revenue D i f f u s i o n Fund

Committee;

( 2 ) t h e change i n t h e funds t o be d i f f u s e d

r e l a t i v e t o t h e i n l a n d revenue; and

( 3 ) t h e change i n t h e funds t o be d i f f u s e d

r e l a t i v e t o t h e Gross Domestic Product .

5 We d i d not d e r i v e a m u l t i p l i e r f o r the need f a c t o r s i n c e

i t s performance could be b e s t understood i n t h e Gross Domestic P r o d ~ ~ c t express ion .

The mathematical e x p r e s s s i o n s of t h e s e t h r e e o p t i o n s a r e :

I n t h e case of ( I ) , t h e amount of money t h a t d i f f u s e s

t o a g iven s t a t e , r e l a t i v e t o t h e quantum i n t h e fund, depends

on t h e s i z e of t h e popula t ion , t h e t a x revenue t o Gross Domestic

Product and t h e expor t t o import r a t i o . From t h i s o p t i o n , a

g iven s t a t e h a s f i v e p o l i c y d e c i s i o n s . I t has c o n t r o l over

popula t ion ; i n l a n d t a x e s ; GDP; e x p o r t s and imports . A l l , excep t

popula t ion , a r e manageable i n t h e s h o r t run .

The second c a s e , namely t h e amount of money t o be d i f f u s e d

t o a s t a t e r e l a t i v e t o i t s i n l a n d revenue, i s a u s e f u l one. I t

i n d i c a t e s , g r a p h i c a l l y , t h a t any s t a t e may improve t h e l e v e l of

i t s r e c e i p t s by improving t h e l e v e l of i t s t a x revenues . But,

s p e c i f i c a l l y , t h i s c a s e sugges t s t h a t f i s c a l l y s t r o n g economies

a r e c r i t i c a l t o the t a x e f f o r t . Here, t h e buoyancy of component

G and t h e s i z e o f N - a r e c r u c i a l shor t - run i n d i c a t o r s . .I

Turning t o t h e revenues t o be d i f f u s e d r e l a t i v e t o t h e

Gross Domestic Produc t , we n o t e t h a t t h e r e i s an i n v e r s e r e l a -

t i o n s h i p between t h e two v a r i a b l e s . Here, t h e v a l u e s of money

c o l l e c t e d , t h e popula t ion , t h e t a x revenues and t h e need f a c t o r

are a l l a composite r e l a t i v e t o t h e square of t h e Gross Domestic

Product . I n t h i s c a s e t h e r e a r e shor t - run and long-run v a r i a b l e s

t o be manipula ted.

C . A Numerical I l l u s t r a t i o n of t h e Model:

Using d a t a f o r 1975 and f o r S t . K i t t s , we can i l l u s t r a t e

how much money S t . K i t t s would have g o t t e n from t h e RDF were i t

i n o p e r a t i o n then . From ( 3 . 0 ) we know t h a t :

The fo l lowing d a t a a r e from t h e Eas t Caribbean Common

Market -- Digest of S t a t i s t i c s (1975) and t h e Annual S t a t i s t i c a l

D i g e s t , S t . Kit ts-Nevis-Anguilla (1978), a l l d a t a a r e i n thousands ,

excep t t h e r a t i o s .

G - - $1452.79 [lX of local . revenue] P - - j

46 -

'i - 528.8

T - - j

15,437

The v a l u e of R ( t ) = $185,857. T h i s means t h a t S t . K i t t s .

gained $31,489 ($185,859-$154,370) by j o i n i n g t h e RDF and

e x e r c i s i n g i t s o p t i o n t o draw from t h e RDF. The $154,370 is

t h e one p e r c e n t l o c a l revenue c o n t r i b u t i o n t h a t S t . K i t t s would

have been r e q u i r e d t o make i n 1975. I f S t . K i t t s e x e r c i s e s poor

economic p lann ing i n a given yea r and i f t h i s p lann ing r e s u l t s

i n n lower e x p o r t s t o import r a t i o (our need f a c t o r ) a s w e l l as

a lower t a x e f f o r t , t h e amount t h a t S t . Kitts w i l l g e t w i l l be

lower. I t i s t o be remembered t h a t t h e RDF is no t a s u r r o g a t e

f o r poor f i s c a l p lanning. It i s a reward f o r prudent f i s c a l

management . The v a l u e s of t h e "mul.tiplierr," g iven t h e numerical

lralues f o r t h e S t . K j t t s d a t a above are :

The m u l t i p l i e r s may be i n t e r p r e t e d as fol lows: I n t h e c a s e

df R ( t ) r e l a t i v e t o G, a s t a t e w i l l g e t 1 . 3 c e n t s f o r every a d d i t i o n -

a l d o l l a r of funds t o be d i f f u s e d t o t h e s t a t e . O r pu t i t ano ther

way, a one p e r c e n t i n c r e a s e i n G b r i n g s about 1 . 3 p e r c e n t i n c r e a s e

i n R ( t ) . Likewise a one p e r c e n t i n c r e a s e i n T b r i n g s about a 1 . 2 1 j

percen t i n c r e a s e i n R ( t ) . And, i n t h e case of Q j , a one p e r c e n t

i n c r e a s e i n Q . b r i n g s about a . 3 p e r c e n t decrease i n R ( t ) . J

IV. CONCLUSION

The Revenue D i f f u s i o n Fund is a mechanism which s e e k s t o

minimize t h e f i s c a l i n s t a b i l i t i e s from which many Caribbean

governmentssuffer . The RDF is a poo l of funds . From i t funds

a r e d i f f u s e d from s u r p l u s c o u n t r i e s t o d e f i c i t c o u n t r i e s . I n

our e s t i m a t i o n , the RDF is on ly a necessa ry c o n d i t i o n . It

should be seen a s impor tan t , n o n e t h e l e s s , because i t could be

a mechanism of t h e r e g i o n ' s own s e l e c t i o n w i t h t h e s o l e purpose

of u s i n g t h e r e g i o n ' s own funds towards s e l f - s u f f i c i e n c y . It is

necessa ry because , we b e l i e v e , i t could s e r v e a s a f u r t h e r incen-

t i v e f o r coord ina t ion i n r e g i o n a l f i s c a l p lann ing a t t h e l e v e l of

t h e Caribbean-Nation S t a t e . The RDF i s necessa ry , a l s o , because

i t may minimize t h e l i k e l i h o o d of Is land-Nat ion S t a t e s e n t e r i n g

t h e c o n d i t i o n a l i t y t r a p of t h e IMF o r o t h e r l end ing agenc ies

(Odle, 1978) . What guaran tees e x i s t t h a t :

(a) t h e RDF i s workable?

(b) t h e Island-Nat ion S t a t e s would adhere

t o t h e r u l e s ? and

(c ) i t would n o t be dominated by t h e l a r g e r

c o u n t r i e s i n the Caribbean-Nation S t a t e ?

There a r e no guarantees. However, we be l i eve t h a t it is workable

given:

(1) the politico-economic necessary and

s u f f i c i e n t condi t ions f o r t he in t eg ra t ion

of monetary and f i s c a l p o l i c i e s a t the

Caribbean-Nation S t a t e l e v e l ; and

( 2 ) the need t o have co l l abo ra t ive economic

planning, s ince the f i s c a l inadequacies

of an ind iv idua l s t a t e tends t o have

negat ive sp i l l -over e f f e c t s on o ther

s t a t e s i n the region.

Any guarantee of a workable RDF, t he re fo re , r e s t s on the co l lec-

t i v e i n t e r e s t s of the r eg iona l s t a t e s and the ind iv idua l states.

The s t a t e s ' percept ion a t the Island-Nation S t a t e s ' l e v e l and a t

the Caribbean-Nation S t a t e w i l l , i n the long-run, determine i f

t h i s money cooperative e f f o r t or any such e f f o r t w i l l work.

In the f i n a l ana lys i s , then, a S t a t e ' s adherence o r non-

adherence t o t he r u l e s and r egu la t ions of the RDF would depend

on the c o l l e c t i v e i n t e r e s t s of the Caribbean-Natlon S t a t e and the

Island-Nation S ta t e s . Imp l i c i t l y , t h i s c o l l e c t i v e view i s a type

of "moral" ob l iga t ion of the reg ional p o l i t i c a l d i r e c t o r a t e .

Since moral i ty alone cannot run a country, we suggest t he re

should be f u r t h e r negat ive sanc t ions , i n add i t i on t o those

mentioned before under t h e penal ty sec t ion .

I f an ind iv idua l s t a t e v i o l a t e s t he r u l e s and r egu la t ions

of t he RDF, such a s t a t e should be barred from obta in ing loans

from the RDF f o r a spec i f i ed period of t i m e . Those s t a t e s which

engage i n t r ansac t ions with t h e debarred s t a t e should a l s o be

penal ized i f the debarred s t a t e b e n e f i t s from t h e t r ansac t ion a t

the expense of the RDF. What do we mean?

Suppose S t . K i t t s v i o l a t e s t h e r u l e s of the RDF. I f

Trinidad lends S t . K i t t s money a t r a t e s more favorable than the

RDF r a t e s , then Trinidad should be penal ized according t o the

" r a t e d i f f e r e n t i a l p r inc ip le" e s t ab l i shed under the penal ty

sec t ion . Funds, i n the RDF, which belong t o a debarred country

should be frozen from i t s use f o r the time of debarrment. The

debarred s t a t e should not have an automatic r i g h t t o withdraw

i t s funds from the RDF. However, when the period of debarrment

ends, the debarred s t a t e should g e t t h e b e n e f i t s 05 i t s con t r ibu t ion

and a l l i n t e r e s t s t h a t i ts con t r ibu t ion accrued - t h a t is i f the

s t a t e needs the money. 6

We wish t o make it abundantly c l e a r t h a t t he Revenue Diffusion

Fund is merely one attempt a t minimizing the cons t ra in ing and con-

*

6 A s t a t e need not take back i t s money from the RDF immediate-

l y a f t e r i t r een te r s the RDF system. See Appendix f o r an indica- tion of the procedure it may adopt.

s t r i c t i n g fo rces of the Caribbean reg ional s t a t e s i n t h e i r borrow-

ing from e x t e r n a l sources. There a r e many inherent problems i n

t he mechanism of t he RDF. Nevertheless, it could be a startiqg point

t o cu t down on the dependency on fore ign borrowing. The RDF, how-

ever , should not rep lace a l l fore ign borrowing i n one massive d i s -

placement. We suggest t h a t t h e r e should be a phase-in period,

from high ex te rna l borrowing t o the RDF, over a ten-year per iod.

The phase-in of the RDF and the phase-out of fore ign borrow-

ing suggests t h a t , i n i t i a l l y , the quantum of funds i n t he RDF

should be very small . The l a rge s t a t e s may wish t o draw on the

RDF a t some period when the percentage r a t e of growth of t h e i r

cont r ibu t ions t o the RDF equals the a l t e r n a t i v e earn ings of t h e i r

con t r ibu t ion a s measured by the r a t e of i n t e r e s t . 7

The phase-inlphase-out per iod of the RDF and fore ign borrow-

ing should be a period f o r eva lua t ing the mer i t s ldemer i t s of both

the RDF and fore ign borrowing. Normatively, we be l ieve t h a t the

RDF could be superior t o fore ign borrowing. However, t he p o l i t i c a l

d i r e c t o r a t e of the ind iv idua l s t a t e s has t o decide on the opt ions

opened t o br inging the Caribbean-Nation S t a t e toge ther . The

p o l i t i c a l d i r e c t o r a t e w i l l a l s o have t o decide what i s the bes t - so lu t ion f o r the f i s c a l c r i s e s of the s t a t e s f o r a l l of the s t a t e s

'see the Appendix f o r an i l l u s t r a t i o n of t h i s concept.

and not some of t he s t a t e s .

I n the end, whether a mechanism such a s t h e RDF is adopted,

or no t , depends on the long-run f e a s i b i l i t y of t h e p l an a s w e l l

a s the p r a c t i c a l a l t e r n a t i v e s t h a t a r e ava i l ab l e t o s t a t e s . I f

those a l t e r n a t i v e s have a s t rong s u b s t i t u t i o n e f f e c t , then the

RDF w i l l not be considered. I f a l t e r n a t i v e s t o fore ign support,

fore ign a i d and dependency diminish, over t ime, then mechanisms

of s e l f - su f f i c i ency , such a s the RDF, w i l l a t t a i n p r i o r i t y i n

the matr ix of decision-making of the reg ional p o l i t i c a l d i rec to-

r a t e . The present conjuncture of forces , events and condi t iona l i -

t i e s i n the ex t e rna l lending market,suggest t h a t se l f - suf f ic iency

has t o be accorded g rea t e r p r i o r i t y . It is i n t h i s s p i r i t t h a t

the RDF is of fered .

A s t a t e need not t ake i t s money from t h e RDF immediately

a f t e r i t r e t u r n s t o t he RDF. I n addi t ion , a l a r g e s t a t e which

may have t h e capac i ty t o ge t e x t e r n a l funds - a t b e t t e r r a t e s

than from the RDF - may want t o leave i t s con t r ibu t ion i n t he

RDF f o r a per iod of time. How would t h i s b e n e f i t t h e RDF and

the s t a t e ? I n t he case of t h e RDF, more funds w i l l be ava i l -

ab l e f o r investment and a l s o disbursement t o d e f i c i t s t a t e s .

I n the case of a s t a t e which op t s no t t o "take i t s par tner -

hand" when i t s tu rn comes up, l e t us consider t he fol1,owing

F isher ian Investment dec i s ion (F isher , 1930; S i lberberg , 1978) .

Assume t h a t the con t r ibu t ion t o the RDF e n t e r s a t time

t = 0 and grows i n value t o R( t ) a t time t . Assume t h a t we have

a smooth d i f f e r e n t i a l funct ion and t h a t the func t ion inc reases a t

a decreasing r a t e . I n o ther words, the f i r s t d e r i v a t i v e of R(t)

i s p o s i t i v e and the second d e r i v a t i v e i s negat ive:

R 1 ( t ) > O (A. 1)

R"(t) < 0 (A. 2 )

A t what t i m e should a s t a t e take i t s "partner-hand" from the

Revenue Diffusion Fund such t h a t i t would getthemaximum value?

To f i nd the va lue , we de r ive the presen t value of t h e amount.

Assume continuous discount ing. The presen t value w i l l be:

R = ~ ( t ) e - ~ ~ s ( A . 3 )

According t o the maximization r u l e , we need t o set t h e change

i n t h e presen t va lue f o r t he s t a t e (Rs) equal t o zero:

-it- d Rs = ~ ( t ) ( - i z i t ) + ~ ' ( t ) e - 0 ( A . 4 )

d t

Dividing through by we ge t

We may i n t e r p r e t (A.5) a s the percentage r a t e of growth. I n

essence, what the above suggests is the following: A s t a t e could

maximize t he amount i t w i l l g e t from the RDF i f i t takes i t s money

a t t he time when the percentage r a t e of growth of t he va lue of t he

con t r ibu t ion equa ls the a l t e r n a t i v e earn ings (of t h e con t r ibu t ion )

a s measured by the i n t e r e s t r a t e . I f R( t ) is known, t he contr ibu-

tion-maximizing time, t , is e a s i l y der ived. 1

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(7) Odle, Maurice A. , "Guyana - Caught i n an IMF Trap" Caribbean Contac t , Vol. 6 , No. 6 , October, 1978.

(8) Pechman, Joseph A . , "Revenue Shar ing Revis i t ed" i n F inanc ing S t a t e and Local Governments, Federa l Reserve Bank of Boston, Conference S e r i e s No. 3 , Boston, Massachuset ts , 1970.

(9) S i l b e r b e r g , Eugene, The S t r u c t u r e of Economics: A Mathematical Ana lys i s , New York: Mc-Graw H i l l Book Company, 1978.

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