Local Capacity Development: The Key to Benefiting from Globalization and Reducing Unemployment in the DR Jos Caraballo, Ph.D

Local Capacity Development:

Jos Caraballo, PhD2012 GFDD Fellow

Local Capacity Development: The Key to Benefiting from Globalization and Reducing Unemployment in the DR

BackgroundReasons for conducting research in the DR: my major was development, looking for examples from other countries, and I love my second homeland!

Acknowledgements: extraordinary support from the Fellows Program of the Global Foundation for Democracy and Development and their affiliates.

IntroductionIn 1950 DR had a larger GDP per capita than many of the so-called Asian TigersSimilarities: both were open to foreign investments and trade, both had similar human capital resources in the 1960s (Rodrik, 1995), both were affected by political turmoil in the last century, and both suffered colonialismWhat, then, happened?Figure 1. GDP per capita Dominican Republic and South Korea, 1950-08

Differences: -Korea focused on building local capacity; DR on attracting foreign capital (Free Trade Zones established in 1969). -Import Substitution in Korea required export attainment, DR local markets. - DR focused on low value-added products, Korea in high value-added products.Recent Issues:Impact of International TradeRicardian theory assumes: perfect competition real wages = productivity employment neutrality factors are homogeneous trade balanced and countries have their own productive capacity.

None of these applies to DR.Simple Representation of Trade with Economies of Scale

China has benefit from trade, but not is not free.Lower Prices from DR-CAFTA? Prices in the Food, Beverages and Tobacco sector increased by 23% from 2006-2010, and by 16% in 1996-2000 Footwear and Apparel prices increased 22% after free trade, compared to 8% in 1996-2000 Furniture and Accessories prices increased by 14% in the later period vis--vis 19% in the previous one. Further ArgumentsExports headed to the US (about 68% in 2006)? But not from Dominican firms. Major exports: Cigars, ferronickel, underwear and sugarcane. - Imports of petroleum and its derivatives as a proportion of total imports increased by 10% between the periods 1994-2002 and 2004-2011.- All countries participating in the DR-CAFTA currently have a negative trade balance with the US. DRs was 16% of the nations GDP in 2011, while most South American countries have a positive trade balance.

Diluting effect: remittances-- $3.2 billion in 2011-- and the $4.3 billion received from the travel sector were not enough to offset the $8.9 billion trade deficit in goods.US large trade deficit? 3% and dollar.Foreign production should complement local, but in the last 18 years 80% of all exports in goods and services originated from foreign companies.

HaitiIn 2006, 4.5% of Dominican exports were headed to Haiti. In 2010 the number rose to 13.2%, without considering informal exchanges.If Free Trade Zones are excluded, it is best trade partner. In total exports, higher than E.U.Market to develop infant industries: clothes, meat, sugar, soy oil, wheat flour, and baked goods. Employment benefits.Employment by Company Size, 2000-12Labor MarketKey for development: full employment.Unemployment rate has never been lower than 12%.From 1991 to 2011,real GDP more than tripled and per capita grew by 128%. However, in real terms, the vast majority of the population was earning less in 2011 than in 1991.trickle-down effect and marginal productivity theory? Even Warren Buffett, arguably one of the wealthiest men alive today, has criticized the trickle-down theory (Buffett, 2011).However, productivity grew on average by 2.2% in the 1996-2007 period, higher than the Latin American average in recent years, and higher than Mexico and Brazil in the last 18 years (ECLAC, 2012).This begs for labor institutions. However

Problems with Neoclassical ModelPerfect competition Unemployment with informal market No connection with growth . Hire more only because of lower cost? Productivity decrease Real wages decreased 24% from 2000 to 2010, but unemployment increased from 13.9 to 14.3% No output composition No evidence (lower unemployment after increases in Social Security) Suboptimal labor demand due to a faulty growth path Can we blame migrants?Migrants employed in jobs that locals are not willing to undertake, including the harvesting of sugarcane and non-skilled construction.In the 1996-2011 period, the decrease in real wages was higher (33%) in sectors such as Commerce and Hotels and Bars and Restaurants, than in sectors such as Agriculture (29%) or Construction (23%) where migrants, mostly Haitian, are concentrated.

Other Labor Market ChallengesIn the 2003-2004 financial crisis, the unemployment rate for women increased by 7 percentage points in the urban sector, while for men it decreased by 0.02 percentage points. Even in the formal sector, women earned 19% less than men. Barrier to development since 27% of all households were headed by a female.Half of all young workers in the DR are employed in the informal sector, and almost all of the remaining half are without salaries.This might explain the high rate of murders

Gap Between Informal and Formal Employment, 2000-2011

Despite high growth (5% for the last 30 years), the current economic model in the DR fails to adequately create neither the quantity nor the quality of suitable jobs the country needs. Jobless growthEconometricsChanges in Unemployment vs. Trade Balance Growth, 1970-2006

Okuns equationConstant0.02**(0.008)Lagged dependent variable-0.29**(0.11)Growth of GDP-0.42**(0.13)R0.414.7% does not change the unemployment rate

Other versions:Constant0.04***(0.01)Lagged dependent variable-0.317**(0.11)Output Gap-0.364***(0.09)R0.46Constant0.002(0.005)-0.001(0.005)0.004(0.005)0.016**(0.0067)0.025**(0.008)Lagged dependent variable-0.30**(0.12)-0.25*(0.13)-0.28**(0.13)-0.35**(0.12)-0.28**(0.12)Growth of Free-Trade Zones0.02***(0.005)0.02***(0.0056)0.02***(0.006)0.026***(0.0053)0.028***(0.005)Growth of Other Services in period t-1-0.10*(0.07)-0.05(0.07)-0.05(0.06)-0.08^(0.06)Growth of Hotels, Bar and Restaurants-0.05*(0.02)-0.035*(0.02)-0.035*(0.02)Growth of NFTZ Manufacturing in period t-1-0.28**(0.10)-0.244**(0.098)Growth of the rest of GDP in period t-1-0.20**(0.10)Adjusted R0.390.350.380.500.55Growth in Conventional Manufacturing and in Employment, 1996-2011Growth in Free-Trade Zone Manufacturing and Employment, 2001-2011Growth in Tourism and Employment, 1997-2011Growth in Other Services and Employment20111996SectorContribution to GDPContribution to EmploymentContribution to GDPContribution to EmploymentAgriculture7.614.710.419.9Mining and Quarrying0.40.051.00.4NFTZ Manufacturing18.97.022.112Free-Trade Zones2.73.14.76.5Construction4.26.25.96.7Commerce9.022.010.819.8Hotels, Bars and Restaurant6.15.96.74.8Transportation and Communications21.37.49.06.7Utilities1.30.81.60.5Finance and Insurance4.02.52.21.4Public Administration1.04.97.74Other Services5.025.28.317.4JobsAgriculture, Commerce and Other Services are sectors that represent a relatively low contribution to GDP, but a very high one to employment. Those three sectors represented 22% of total production, but provided 62% of all employment. Agriculture provides more jobs to the Dominican economy than the Mining, Free-Trade Zones and Hotels sectors combined. AgricultureNet importer of food.Unfair competition from the US and unsophisticated technology: tractors used per 100 square kilometers of arable land, DR was in 67th place among 78 countries in 2010. DR has proportionally fewer tractors than countries such as Kenya or Djibouti, while Dominican GDP is more than double Kenyas and 48 times more than Djiboutis. Could reduce incidence of low calorie consumption, of which the DR has one of the highest rates in the Americas.

Conclusions and RecommendationsForeign capital should complement, not substitute, domestic capital. GDP growth that does not decrease the high structural unemployment nor increase the average real wage cannot bring high development.Target should be decent job creation to reduce poverty and inequality.Not state-led growth, but state-led development. Impulse to local firms.Funds for that program? Tax gambling (only 0.25% of revenues), luxury housing and heritages (less than 1%), capital gains (only US $2,700!), tourism (2.5% of revenues) conditional on time money circulates to create money market, and mining (only 0.5%).Even Buffett does not support a policy of low taxes on capital gains.Pay higher salaries to tax collectors to reduce evasion.Other RecommendationsAgriculture: remove intermediaries from value chain, increase high value-added niches and lower interest rates for agricultural technology. Increase data availability.Manage competition.Increase communication with local firms. Require exports achievements. Provide marketing assistance.Require horizontal linkages to FDI.Increase minimum wage periodically with productivity gains.Look for South-South trade agreements.Free Trade Zones: demand concatenation and improved working conditions.Educate about technological options for transferring remittances.Cooperatives.Affirmative action laws.