Two Caribbean islands, alike in nearly every way, provide what Stanford Graduate School of Business economist Peter Henry calls “as close to a laboratory experiment as you could hope to find in social sciences” for testing what factors lead to a country’s economic success or failure.
In a new study forthcoming in the American Economic Review, Henry and Conrad Miller, a Stanford undergraduate, show that, contrary to conventional theories of economic growth, it’s not necessarily the differences in the laws and institutions under which countries operate that drive differences in their economic development. Rather, it’s the set of economic policies and decisions a government makes that are critical. In the 1960s, Barbados and Jamaica both received their independence from Great Britain. As former British colonies, the two islands were strikingly similar in many ways. Culturally, both were inhabited by the descendants of Africans who were brought to the Caribbean to cultivate sugar. Institutionally, Barbados and Jamaica both adopted English common law, Westminster Parliamentary Democracy, and strong constitutional protection of private property.
In spite of their legal and institutional similarities, Barbados and Jamaica experienced starkly different growth trajectories in the aftermath of independence. From 1960 to 2002, Barbados’ gross domestic product, per capita, grew roughly three times as fast as Jamaica’s. Consequently, the income gap between Barbados and Jamaica is now almost five times larger than at the time of independence.
Much of this income gap came about because of the sharp decline in Jamaica’s standard of living after 1972.
In 1973 the first world oil price shock triggered a global economic slowdown. Like most other countries, Barbados and Jamaica began to experience higher inflation and lower growth (also known as stagflation). But growth slowed much more rapidly in Jamaica than it did in Barbados. While Jamaica’s economy contracted at a rate of 2.3 percent per year from 1972 to 1987, Barbados, whose economy has a similar structure and was subject to the same shocks, grew by 1.2 percent per year. In other words, for a 15-year period standards of living in Barbados grew by 3.5 percentage points faster than in Jamaica.
As a result, the income gap between the two countries moved. In 1960 the real per capita GDP in Barbados was US$3,395, compared to US$2,208 in Jamaica—an income gap of US$1,187. By 2002 Barbados’ real GDP per capita stood at US$8,434 versus US$3,165 in Jamaica—an income gap of US$5,269.
What specifically led to such starkly different trajectories?
The difference, Henry and Miller observe, is that in the 1970s the Jamaican government chose to respond to the nation’s economic woes by running large and persistent fiscal deficits (which it financed by printing money), nationalizing companies, erecting import barriers in the form of higher tariffs and outright bans, and intervening extensively in the economy. Barbados, on the other hand, avoided nationalization, kept state ownership to a minimum, and adopted an outward looking growth strategy while keeping government spending under control.
Eventually, Jamaica felt it had no other choice but to devalue its currency. When faced with a similar decision in 1993, Barbados was able to avoid devaluation by making other hard choices. The government negotiated with firms, unions, and workers to institute a one-time wage cut. Firms promised to moderate price increases, and all parties agreed to the creation of a national productivity board to provide better data on which to base future negotiations.
Although the new wage protocol caused court battles and forced sacrifices on all sides, it prevailed—enabling the government of Barbados to maintain its fixed exchange rate without undermining the competitiveness of the economy’s export sector.
The experience of these two Caribbean nations holds lessons for governments, both large and small, grappling with the current global crisis, says Henry, the Konosuke Matsushita Professor of International Economics at Stanford GSB. “While there is a legitimate and helpful interim role for governments to play in restoring the financial sector back to health,” he says, “extensive and ongoing government intervention in markets—along with the protectionist sentiment that it is likely to arouse—has the potential to cause many more problems than it solves.”
“I worry about the rise of protectionism, be it raising tariffs to protect domestic industries against foreign goods or providing ill-advised subsidies to companies to give them a leg up against foreign competition. In comparing the case of Jamaica and Barbados, it’s pretty clear that protectionist policies really hurt a country’s economy in the long run,” Henry observes. “What we don’t need now is for countries to simply look out for their own interests. We need a coordinated response in which we realize that we’re all in this together.”
