South Pacific Study Vol. 19, No. 1-2, 1999

Private Sector Development and Competitionin the South Pacific: A Case Study of Vanuatu
Tiru K. JAYARAMAN

Abstract

The South Pacific island countries (SPICs) have initiated since the early nineties various reform measures
towards economic restructuring their economies. As part of the reforms, a greater role for private sector has beenenvisaged. In addition to privatization of their commercially non-viable public enterprises, a more friendly climate
is being created for private sector development, with emphasis on attracting foreign direct investment (FDI).
Together with an already prevailing conducive macroeconomic environment in terms of low rate of inflation anda relatively stable exchange rate, which has been chiefly facilitated in the past by the generous ODA flows
avoiding serious balance of payments difficulties, special incentive packages and tax holidays for promoting
private domestic investment and FDI are being offered. Despite these efforts, domestic private sector development
has been slow. Further, there has been no dramatic increase in FDI flows. On the contrary, in certain SPICs there
have been some pull outs. It is obvious that although deregulation measures including privatisation efforts could
be the necessary conditions, the sufficient conditions lie elsewhere and they appear to be relating to various
restrictive circumstances hampering free functioning of competitive forces. The paper undertakes an analysis of thecauses behind the poor private investment climate despite various initiatives to deregulate and privatise andidentifies areas for improvements for promoting competition.
Key words: privatization, restructuring, competition, monopolies, governance issues

Introduction
As they enter the twenty-first century, the South Pacific island countries (SPICs) findthemselves lagging behind the fast-paced deregulation of economic activities and dismantling of restrictive trade and tariff regimes in all the developing economies. Coupled withthese developments, there has been a downward trend in concessional official development
assistance (ODA) flows to the developing world as well. Any remaining hopes among
SPICs whose dependency on ODA is fairly substantial, that the newly emerging donors,
including Japan and Korea would take up the task of maintaining the past aid levels were
belied by the South Pacific Forum-Japan summit meeting in October 1997. The summit
meeting confirmed the fear that there was no basis for any such expectations, as Japan’scurrent financial difficulties might continue for a while. Furthermore, the currency andfinancial crises which have engulfed Korea in particular, and the Southeast Asian nations
have also sent a harsh message that SPICs have to set their houses in order.
This is a revised version of the paper presented at the Conference on "Competition and Law" held in Valetta, Malta
under the auspices of the Islands and Small States Institute and the Foundation for International Studies, in July
1997.

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South Pacific Study Vol. 19, No. 1-2, 1999

The fall in ODA flows which were mainly directed in the past to the public sector in
SPICs, has been due to revisions in aid policies following an evaluation that the public
sector programmes and projects funded by ODA in the past were poorly implemented andineffective and a direct support to private sector role could be more productive in terms ofcreation of employment opportunities and higher incomes (JAYARAMAN, 1995b). The near
universal acceptance of a change in the philosophy towards greater reliance on market
forces was also reinforced by the collapse of the former Soviet Union. In addition to aid
fatigue, there have been fiscal pressures as well, in the donor countries which led to gradualreduction in aid levels.
After effecting cuts in their annual budgetary support to SPICs for recurrent expendituresin the early nineties, the bilateral donors in their attempts to maintain their project assistanceat the 1990 levels have been finding out ways for ensuring better utilisation of funds.
Consequently, they have been seeking, in close collaboration with the multilateral donors
including the World Bank (WB) and the regional Asian Development Bank (ADB),
certain conditionalities to be met by SPICs. They come under the general prescription of
public sector restructuring and reforms and provision of a far greater role for the private
sector.
Implementation of reforms in SPICs are at different stages. A greater role for private
sector has been envisaged and one immediate avenue has been attempt to privatise thecommercially non-viable public enterprises. Additionally, a more friendly climate is being
created for private sector development, with emphasis on attracting foreign direct investment (FDI). Together with an already prevailing conducive macroeconomic environment
in terms of low rate of inflation and a relatively stable exchange rate, which has been
chiefly facilitated in the past by generous ODA flows avoiding serious balance of payments
difficulties, special incentive packages and tax holidays for promoting private domestic
investment and FDI are being offered. Despite these efforts, private sector development has
been slow and FDI flows have not registered any dramatic increases and on the contrary,in certain SPICs there have been some pull outs. It is obvious that although deregulation
measures including privatisation efforts could be the necessary conditions, the sufficientconditions lie elsewhere and they appear to be relating to various restrictive circumstances
hampering free functioning of competitive forces.
The objectives of the paper are to: (i) undertake an analysis of the causes behind the poor
private investment climate despite various initiatives to deregulate and privatise and (ii)identify areas for improvements. The paper is organised into three sections. The first section
provides an overview of some recent trends in SPICs in the area of deregulation andprivatisation efforts; the second section, specifically focusing attention on Vanuatu, a small
island country, which is a tax haven with no exchange controls and a reasonably favourable
macroeconomic environment, explores the shortcomings and the last section discusses
policy implications.

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

3

1. An Overview of Recent Trends in Deregulation in SPICs

The SPICs in the last two decades have invested on an average, about 29 percent of GDP
per annum in their economy (Table 1). More than 50 percent of this investment was in the
public sector (JAYARAMAN, 1995a) Despite these efforts, economic growth has been poor.
Relatively long gestation periods, poor implementation and bureaucratic inefficiencies
together with some unproductive investments have been cited as the causes of less than
optimal returns (World Bank 1993). Further, the trade regimes in terms of restrictions andimport licenses and high tariff rates, which are more for revenue purposes than for major
import substitution activities, have been hurting exports by creating an anti-export bias.
The expansive fiscal policies, partly encouraged by ODA and partly supported by a belief
that indigenous private sector would not be able to undertake commercial activities 1 andthere was an absence of individual profit motive as compared to the Asian societies. Thereis however growing evidence (QALO, 1997) which has belied this particular view point,
pointing to the emergence of entrepreneurial talents among the ethnic majority. There canbe no denying of the fact that this is due to demonstration effect of successful ventures by
the members belonging to non-ethnic communities in Fiji. Some of these have been past
employees in successful private sector undertakings and some who have taken early retirement from disbanded government departments and public enterprises, were involved in thegrowing public sector, in even such extreme commercial activities such as duty free shops,
as was in Tonga and travel agency services in Tuvalu, not to speak of the marketing boards
for copra and other export crops. Poor performance of these public enterprises have been
Table1. Selected economic indicators for developing Asian and Pacific countries
Population

GNP

Percapita GDP Growth Growth Rate Openness

Thousand (US＄Mil) Income US＄

Rate

in Exports

Ratio ofFiscal Defisit Current Account Inflation(Ratio of GDP)

BalanceAnnual(percent) (percent) Exports andAnnual(Ratio of GNP) Average

Imports to GDP

AverageAnnual Average (percent)(percent) (percent) (percent)
1996

1995

1995

Fiji

807

1895

2440

2.5

3

75

18

- 5

12

Solomon Islands

396

341

910

5.5

19

98

4

- 1

4

Tonga

97

170

1630

3.8

24

55

11

-10

4

Vanuatu

173

202

1200

2.5

9

48

24

-25

6

1991-1995 1990-1995

1995

1990-1995 1990-1995 1990-1995

Source: ADB (1996)

1 There has been a general lack of indigenous private entrepreneurial talents in the SPICs with the exception ofFiji. This particular deficiency has been attributed to the unique sociocultural characteristics that the South
Pacific societies are communally oriented on the principle of caring and sharing (SCHOEFFEL 1995).

4South Pacific Study Vol. 19, No. 1-2, 1999

contributing to fiscal burden, as they were regularly subsidised from the general budgets,
cutting down more essential maintenance expenditures. Deterioration in public finances also
threatened the excessive credit growth or crowding out of the viable private enterprises.
Further, it seriously undermined the limited role of monetary policy in demand management(BROWNE, 1995).
Inflation in SPICs has been generally low, except in the Solomon Islands, which had
experienced a double digit inflation during the early nineties mainly due to expansionary
fiscal policies. Further, there were no serious and unsustainable current account deficits inthe balance of payments since ODA receipts provided the cushion. However, the exports
did not pick up in the mid-eighties as the nominal exchange rate was found overvalued.
There was a wedge between the nominal and real exchange rates since domestic inflation
was still higher than the overseas inflation rate.

The remedies were obvious. Measures aiming at a reduced role for the public sector byclosing down the poorly performing public enterprises, and observance of greater fiscal andmonetary restraints and a realistic exchange rate management were called for. As it often
happens, the political will in sufficient measure was not forthcoming until 1987, when thetwo military coups provided an opportunity for the technocrats in Fiji to come to the fore,pushing aside past policies and implementing the much needed reforms. Two substantial
doses of devaluation amounting to a total of 35 percent of the Fijian dollar were resorted towhich was accompanied by a firmly implemented set of income and expenditure policies
such that the usual wage fixation in line with price increases was temporarily suspended
enabling the benefits of devaluation to flow in full measure (SIWATIBAU, 1993).
A package of reforms was also announced in 1989 for carrying through the reform
process in other areas. They included: (i) deregulation of the economy by discontinuing
subsidies to those economic activities, where Fiji did not have any comparative advantage
and liberalising imports so that domestic prices were brought in line with world prices; (ii)reduction in budget deficits and contributing to public sector savings, thereby releasing
resources for private sector growth; (iii) tax reforms towards minimising distortions
through rationalisation of tax structure and introduction of a value added tax; and (iv)provision of incentives for attracting FDI in export oriented activities.

The results were convincing as the country recorded better rates of growth than before
and FDI in newly emerging industries such as garments and gold mining as well as in the
traditional tourism sector, registered all time increases. The other SPICs drew substantial
inspiration from the Fijian experience of putting their houses in order. Since there were nocompelling circumstances of the kind Fiji went through in 1987, the urgency was relatively
less. However, the message was clear. Added to these developments, the collapse of theSoviet Union and the initiation of deregulation processes in the former centrally planned
economies in their transition to market economies gave a further boost to the philosophy of

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

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less government with a greater role for the private sector. Specifically, the studies by themultilateral institutions (World Bank, 1993, 1995 and Asian Development Bank, 1993,
1995) and by bilaterals (AusAID 1992, 1993, 1995) and the donors meetings in Paris 1992
and in Suva 1993, 1994 provided further prodding to the SPICs in liberalising their economies.
With no exception, all the SPICs have started their processes: the first step was to doaway with the five-year plan documents, giving indications that the government would
undertake a minimal programme focusing mainly upon capacity creating physical and social
infrastructures, such as roads, ports, power, education and health, leaving the rest to theprivate sector. Further, the governments withdrew from procurement and export activities
by doing away with the list of prohibited commodities and by disbanding the Commodity
Boards; this was followed by either privatising or closing down the non-viable manufacturing activities including copra processing and coconut oil mills as witnessed in Western
Samoa.
On the trade and tariff regimes front, the issue of import licenses for rice and otherconsumer goods was discontinued and tariff rates were gradually reduced and import quota
system was replaced with ad valorem rates. The SPICs’ primary exports, including sugar
and copra and manufactured exports such as garments and leather products do not face
immediate threat as they are covered by various preferential trade arrangements under theLome Convention and South Pacific Regional Trade and Cooperation Agreement(SPARTECA), which are to expected to be phased out during the next ten years. However,measures to improve labour productivity and compete with the Asian producers more
effectively have begun to receive greater attention.

Although the reforms are underway in all SPICs, the rate of progress differs from country
to country. With a view to stepping up the pace of reforms, the ministers of the South
Pacific Forum countries who are responsible for economic policies, met in July 1997 in
Cairns, Australia and endorsed an Action Plan describing the activities for implementation
during the next 12 months and beyond. Table 2 presents the salient features of the Action
Plan, which highlight the need for improving business competitiveness.

Privatisation of public sector enterprises of commercial nature would provide substantial
benefits including infusion of capital and managerial talents and redirection of these enterprises along commercial principles. As regards commercial and trading enterprises in the
public sector such as duty free shops, travel agency and manufacturing enterprises such as
copra and coconut oil, the process was not difficult. There were domestic buyers and theprices at which they were sold were attractive to the governments. But what proved difficult
was the effort to sell off the more management and technology intensive operations such as
the government owned ranches and plantations in Vanuatu, as there were no local buyers
and the only option open was to sell to foreign investors.

6South Pacific Study Vol. 19, No. 1-2, 1999

Table 2. Action plan for provision of policy environment for private sector development
Category

Agreed Agenda

1. Economic
Reforms

1. Develop strategies and identify measures for ensuring essential service delivery
2. Consultation with community groups and private sector for strategies development
3. Identify all issues affection business competitiveness by consulting the private
sector that can be addressed by policy reform a recommend steps for improving
competiveness4. Policies for improving opportunities for private sector development andemployment generation
5. Develop strategies for enhancing efficiency of service delivery and for responding to social impacts of economic structuring

B. Public
Accountability

1. Adopt principles of best practice for public accountability, based on concepts ofopenness with government information and public scrutiny of performance ofthe government and officials
2. Adopt budgetary processes for ensuring full information to parliament
3. Audit of government accounts , state-owned enterprises and publication ofreports
4. Present loan agrements signed with external agencies and guarantees given toparliament
5. Advertise all government / public sector contracts, award competitively andreport
6. Punish those who contravene financial regulations
7. Empower Public Accounts / Expenditure Committees to require disclosure
8. Ensure independence of Ombudsman / Auditor-General with adequate resources
9. Ensure autonomy of the Reserve / Central Bank

C. Investment
Policies

1. Pursue open, liberal and transparent investment policies
2. Consider problem areas and practical impediments to investment (eg. land
tenure, foreign exchange risk and and double taxation)

D. Tariff
Policies

1. Work to wards a common goal of free and open trade and investment
2. Rationalise and progressively reduce tariffs with the aim of removing all
adverse effects of tariffs on the economies
3. Avoid protective tariffs; if there is a need for government support use otherforms of targetted assistance
4. Apply general rate to all goods in circumstances when publically known andclearly defined criteria are met
5. Make available the duty draw back system to exporters
6. Use ad valorem rates except in caes where there are serious valuation problems
7. Levy tariffs on imports at CIF values and not on FOB or Current Domestic
Values
8. Levy excise on domestically produced good at the same rate as on goods subject
to tariffs for health, social or environmental reasons

Source: South Pacific Forum Secretariat (1997)

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

7

The limited indigenous private sector activities have been in simple primary processing
and manufacturing of consumer goods and retail activities. Although affirmative action interms of credit and other support have also contributed to fostering business talents among
the ethnic majority, major investments in manufacturing have been rather slow and whatever undertaken was based on outdated technology. Obviously, the economies of scale
limitations due to smallness of domestic markets prevented adoption of improved technologies. In these circumstances, FDI is the most preferred way (de MELLO Jr., 1997), as it
brings in both capital and enables upgrading the current techniques of production, besides
introducing new goods by using local resources which are unique to SPICs for the nichemarkets abroad. The FDI is not new to the SPICs. All past major activities which are natural
resources-based such as mining, sugar milling and tourist resorts and hotel industry were all
due to FDI. In recent years, there have been new investments which are still natural resource-oriented. These include joint ventures such as palm oil production, fisheries and fishcanning in the Solomon islands with majority holdings by the government. The arrangements have proved beneficial.

There is considerable merit in the current thinking that government shares in many of the
fully owned undertakings as well as in joint ventures should be sold to the public so that theownership is widely shared. However, there has been some reluctance as some of theseundertakings have been bringing in dividends to the government each year, as witnessed inWestern Samoa where the government holds shares in the beer and cigarettes manufacturing. Since there has been a need for developing capital markets in the SPICs, offering
government shares in the profitable concerns for sale to the public would contribute tocreating a market for stocks and eventually facilitate the emergence of such capital markets.

Notable progress has been achieved during the last ten years in SPICs in economic
liberalisation and deregulation. Most of the measures related to reduction on tariffs on
consumer and capital goods and abolition of quotas and import licenses. Domestic manufacturers, especially in Fiji, which has a far greater manufacturing capacity in many consumer
goods such as cooking oil, dairy industry, rice milling, biscuits etc. have to increasinglycompete with the liberal imports by improving their production technology and enhancing
their productivity. Thus, external competition has indeed brought in certain dividends. As
the World Bank Study (1995b) brings out, the impact of deregulation on unemployment
was negligible: Those who were laid off by one unit joined other units in the same industry,
and there was no movement from one industry to another, thus indicating least disruption
requiring re-training and absence of long time unemployment. There were also new
employment opportunities in the newly set-up factories in the tariff free factory zones in
response to the government incentives to attract FDI.

8South Pacific Study Vol. 19, No. 1-2, 1999

However, the initial gains flowing out of trade liberalisation reforms in Fiji in the earlynineties have not been sustained as evidenced in the static number of FDI factories andnumber of people employed. Domestic private investment has been stagnating since 1990
at 5 percent of GDP each year. There is no question of any crowding out effect of government investment, which has been brought down to 3 percent of GDP resulting in some
excess liquidity in the system (JAYARAMAN, 1998a). The World Bank (1995b) rightly
stressed the fact, which is applicable to all the SPICs, that the government should, rather
than focusing attention on trade liberalisation, take initiatives to improve economy widecompetitiveness. Before doing so, the institutional factors have to be looked at. 2 FALLON
and KING (1995) have pointed out and highlighted the need for greater attention to these
aspects by citing the short-lived impact of economic reforms undertaken by Fiji soon after
the military coups of 1987. Their study, referring to the uncertain political situation createdby a racially biased constitution which aggravated the animosities between the two major
races, made it clear that benefits of such reforms could not be sustained for long unless astable predictable investment climate based on political stability and well-defined andrigorously enforced property rights was provided by the government.

Referring to the contributions of NORTH (1990) and WILLIAMSON (1995), FALLON andKING (1995) observe that long term contracts form the basis for production-oriented
activities where fixed and durable assets are employed, as opposed to activities of purely
financial nature where short-term assets can be quickly withdrawn and re-deployed at short
notice in response to changes communicated by spot markets. Long term contracts require
an effective system of regulation, which includes disputes resolution procedures, an independent and effective judiciary and a credible commitment to maintenance of policies andregulations affecting investors. If these conditions are not met, the investors would rather
prefer to be foot-loose; they would concentrate on more mobile and less durable assets; andthey would employ lower technology. These issues, as now part of governance issues are
now receiving wide attention both by practitioners (World Bank, 1992) and academics(WADE, 1995; ISLAM 1996; STREETEN, 1996).

There are barriers to competition within the domestic economies of the SPICs. These
relate to: (i) factor markets; (ii) public utilities; (iii) barriers in financial markets. Thesebarriers give rise to various price distortions presenting major impediments to investment,

2 STREETEN (1996) emphasises the importance of institutional factors while referring to transition economies inthe East Europe and observes that institutional liberalisation should precede stabilisation and stabilisation
should precede the freeing of markets.

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

9whether domestic or FDI. In particular, among the factors the prices of two criticallyimportant non-tradable inputs, land and labour do not reflect their true prices in relation totheir endowments. The effective supply of land is restricted by the land tenure system(Table 3) under which ownership of a very major proportion is vested in communal clans,
other than in Tonga where all lands are vested in the King. There is no market for lands assuch in Tonga where leases can be held after negotiation with government authorities.
In the other SPICs, for example in Fiji, the regulations stipulate that no land can bemarketed unless the land is already earmarked as freehold (10 percent of total land) or
Crown land (7 percent) and only in regard to these two categories are transfers of ownership legally permissible. All other lands have, therefore, to be leased by negotiations by thepotential investor with the land owning clans.
The governments are intensively aware that the restrictive land tenure system has had
adverse effects on long term investment plans and the issues seem anachronistic in modern
economies and they need to be resolved. Many institutional improvements have been
attempted under which native lands are brought under a government sponsored body duly
empowered with legal and constitutional powers to negotiate and formalise the leases onbehalf of the land owning classes for a fairly long period for certain industrial activities.
However, the leases so negotiated and registered are not considered firm and final during
the lease period, since the land owners can revoke and sometimes, do seek to re-negotiate
fresh terms and conditions. Some hotels and tourist resorts in Fiji which have leased vast
areas of land for their facilities and golf courses have been forced to close temporarily todeal with such demands (FALLON and KING, 1995). The associated legal delays in settlingthese cases have further compounded problems of insecurity of land tenure and uncertainty
about property rights, which are now clearly identified as one of the major hurdles to createcompetitive conditions for private investment.
Table3. Land tenure system in SPICs (Percent of total land availability)
Communal / Customary Ownership

Crown / Government Ownership

Freehold

Total

Fiji

83

9

8

100

Solomon Islands

97

3

0

100

Tonga

0

100

0

100

Vanuatu

98

2

0

100

In Tonga, although all lands are vested in the Crown, land use rights are conferred on private individuals /corporate bodies.
In Vanuatu, all lands in rural areas are owned by communities, except in designated urban areas where landownership has been transferred by law with adequate compensation.

The functioning of the labour market is hampered by various factors. The current wage
and salaries determination procedures in SPICs in general and in Fiji in particular requirethat changes in living costs be reflected . As a result, periodical upward revisions are madeto take into account rise in the price levels of all imported consumer goods duties on which

10South Pacific Study Vol. 19, No. 1-2, 1999

are subject to periodical increases. The high import duties were levied more for revenue
raising purposes than for protecting any local industry or for inviting any tariff factory to
get behind the tariff walls. Further, there are restrictions in terms of minimum wage forskilled and unskilled labour. Added to these, there are statutory requirements that employers
and employees should contribute certain stipulated percentages of wages and salaries to thenational provident funds. The near universal practice in the SPICs of setting wages andsalaries in the formal sector by linking with consumer price index changes has createdgrowing gaps between money wage and productivity. Table 4 presents a comparative
picture of wage rates
Since the labour productivity in SPICs is not high as compared to other developing
countries, the governments have recognised the imperative need to raise general workforce
skills, which is a long term process. Until such time, periodical upward revisions in minimum wages would only lead to increases in operating costs which are not commensuratewith productivity gains. Reforms including a review of minimum wage legislation andleaving the wage determination to market forces on an enterprise basis, and creation of
institutions for upgrading human capital and programmes by providing training in trades
and improving skills, require both political courage and pragmatic wisdom.
Table4. Labour costs in SPICs and other developing countries
Country

Average Wage Per Day: US＄
SkilledUnskilled

Indonesia

6

2 to 3

Malyasia

13

5 to 8China

8

2 to 5

Fiji

10

8

5 to 7

5

Tonga

9

8

Vanuatu

16

7

Solomon Islands

Source: For the Asian countries, CHAKWIN and HAMID (1997)
For the SPICs, Asian Development Bank (1996)

Public sector monopolies for provision of basic services such as electricity and water
have been operating poorly resulting in losses, except in Vanuatu. It is not the cost recovery
question, as often thought to be the reason for the financial losses, but it is clear inefficiency, which has led to losses. Raising the rates without improving productivity or bylowering the quality of service may improve financial performance temporarily but would
affect profitability of private sector operations and the input costs would be passed on to theconsumers. Since these public utilities run by the governments in small markets face nocompetition and they have no economies of scale to gain from, the only way to improvefinancial performance is through avoidance of waste by careful management by allowing
full freedom to the managers of these utilities. Public enterprises reforms are underway in

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

11

all the SPICs. The modalities have been in the form of legislative processes by which thesepublic utilities are corporatised and allowed to run on commercial principles under theoverall regulatory control of a designated ministry for public enterprises.
All though some thinking is going on whether to hand over the public utilities to theprivate sector or to a foreign investor on management contract for a fairly long period, as
has already been accomplished in Vanuatu in regard to electricity and water, the questionis whether the SPICs have already acquired sufficient skills and sophistication in the appropriate ministries to exercise the required regulatory control over the natural monopolies in
the private sector. As LAFFONT (1996) notes, the design of regulatory rules andprivatisation programmes of natural monopolies should take into account the characteristicsof the developing countries: (i) the high cost of public funds, as reflected in the social priceof raising one unit of money, which is much higher than in developed countries; (ii) highcost of auditing in the government, as the skills are in short supply; (iii) weak constitutional
controls as special interest groups have a sway over political machinery; and (iv) difficulties in making long term commitments. Since there is a problem of asymmetry of information between the private sector natural monopoly and the regulators in the government, thecontrol whatever exercised by the government would be less than optimal. In such a situation, the natural monopoly in the private sector is worse than a public sector monopoly andthe ordinary consumers of these essential services such as water and electricity and the
production units which consume these infrastruture inputs would be hit hard. Here, one
would recall Joan Robinson’s observation that the invisible hand can also strangulate(STREETEN, 1996).
In these circumstances, retaining the public utilities in the public sector by corporatisingthem and improving their financial and accounting procedures and empowering them withgreater autonomy with minimal interference from political interference would be a far
superior solution than privatisation. This is primarily for the reason that in the case ofgovernment-owned public utilities in developing countries, the information asymmeteryproblem is absent as the government regulators have easy access to information on operations, pricing etc. so that public interests can always be protected (LAFFONT, 1996). Thisof course, presumes the regulators have adequate skills to exercise the auditing and controlling functions as well as the powers conferred by the enabling legislation.

The SPICs have a relatively good financial infrastructure in terms of a large number ofboth foreign and locally owned commercial banks, insurance companies, national provident
funds, housing corporations and development banks. The standard indicator of financial
deepening (the ratio of broad money to GDP) is also fairly high ranging from 45 to 55 topercent. The interest rates have been deregulated now for some time and the real rates ofinterest are now positive. However, the intermediation costs are high and as a result, themargin between the commercial banks’ deposit rates and lending rates is still large. This has
been attributed to various reasons. They range from the prevalent oligopolistic market
conditions in the banking structure to high costs of operations by the banks due to costs of12South Pacific Study Vol. 19, No. 1-2, 1999

communications, expensive expatriate bank management, risky investment and businessenvironment, lack of bankable projects for lending, inadequate security particularly inregard to land, and poor loan appraisal procedures leading to a portfolio of non-performing
assets as well as excess liquidity in the system in relation to demand for credit and holdingof non-interest bearing excess reserves by the banks and so on.
Improving competitive conditions in the banking industry by opening up to competition
from outside as well as achieving better performances of the government’s own development bank and other non-banking financial institutions including provident funds andhousing corporations which lend to indigenous entrepreneurs will go a long way. In addition, the central banks have to get more active in the money markets towards mopping up
the excess liquidity through instruments by issuing securities so that monetary policy can be
more effectively implemented.

The term "getting prices right" does not mean total deregulation and leaving price determination to the market forces which are prone to oligarchic market conditions in specificindustries can also distort prices. 3 There is a role for the government, which is to facilitate
the market forces more efficiently and effectively, given the objective of a kinder andgentler society or any such goal from ethical considerations. In addition to provision of alegal framework and institutions for well functioning of a civil society, the government
should provide a market friendly regulatory system which provides for enforcement ofproperty rights and contracts and legal remedies, besides observing appropriate
macroeconomic policies. Streeten (1996) observes: "There is nothing in the nature of freemarkets that either establishes or maintains competition. On the contrary, free markets makefor conspiracies against the public, as Adam Smith knew it. Yet the virtue of markets
depends on competition."

2. A Study of Vanuatu

The Republic of Vanuatu, which consists of about 80 islands, is located 2300 kilometres
east of Australia and has a total land area of 12,200 square kilometres with a population of
about 170,000. About 20 percent of the population live in the two main urban centres of

3 STREETEN(1996) notes that the term "getting prices right" has undergone curious transformation. In the 1960s
it meant that if prices did not reflect true opportunity costs, shadow or accounting prices were to be calculated.
Further, as actual prices did not reflect the right price, the government should intervene since the unfetteredmarket forces in a given setting of income and asset distribution would cause distortions from an ethical pointof view. This position has now changed and it is held that the government is the source of all distortions andthat developing countries should get rid of all state interventions for enabling market forces to determine prices.
As markets are neutral institutions that can work either for good or evil, there is a need for government
intervention so that markets function for the benefit of people.

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

13Port Vila on the main island of Efate, and Luganville on Santo, the largest island of thecountry. The rest of the population is dispersed among the other islands which have limited
communication facilities. While the two urban centres are marked by thriving tourism
activities, with Port Vila, the capital of the country having the most sophisticated offshore
finance centre institutions in the South Pacific, subsistence agriculture characterises the restof the islands. Inadequate transport communications between the islands have inhibitedinter-island trade and some of the islands have remained remote and have not been brought
into mainstream of economic activities and as result cash economy has still not evolved.
The economy has done well since independence in 1989 from the joint condominium ruleof the British and French. Despite the adverse effects of periodical cyclones, which average
five to eight a year, each of different intensities affecting some part of the country every
time, the economy has grown at 3 percent a year. The year to year fluctuations are, however, considerable. Since the population is estimated to be growing at 3 percent a year, percapita incomes have mostly remained stagnant. However, the subsistence-affluence style ofliving in the remote islands has kept the nation free from any inadequacies in theavailability of food and nutrition. It is only in the urban areas, where modern medicines andprocessed and imported foods have to be purchased with cash, the stagnant incomes havehurt the natives, known as the ni-Vanuatus.
The national accounts data reveal structurally the economy has been undergoing slightchanges in recent years. However, the changes are not significant. The primary sector,
including subsistence activities has marginally declined in importance as its contribution is23 percent to GDP as compared to its contribution of 26 percent in 1983, and the services
contribution has also slightly declined from 67 percent in 1983 to 64 percent in 1995. On
the other hand the secondary sector (manufacturing, electricity and construction) has
increased its share from 8 percent in GDP in 1983 to 14 percent. The economy continues
to depend heavily upon its services sector mainly tourism activities, and increases in theconstruction activities in hotel and resort industry have picked up in recent years after
airline connections to Australia and New Zealand have been increased since the late eighties
following the acquisition of a 737 Boeing aircraft by the national airline.

The macroeconomic environment has been stable (Table 5). Inflation has remained low.
The government followed prudent fiscal policies: the recurrent budget was always balanced
until 1993 and the capital budget was met by external aid, consisting of grants andconcessional loan assistance from the bilateral governments. The overall fiscal balance
contributed to a comfortable external position, although fragile. The external accounts
depended on a narrow range of exports of beef, copra, coffee and kava. As the terms oftrade have been declining in recent years especially in regard to copra, the export earnings
have been declining to a greater extent since copra is the dominant commodity among
exports. Imports are about 41 percent of GDP. The trade deficit is more than offset by
tourism earnings and official transfers representing external aid. The remittances fromoverseas is much less significant in the case of Vanuatu, as compared to Polynesian14South Pacific Study Vol. 19, No. 1-2, 1999

countries. The government followed a very conservative policy in regard to external borrowing until 1996 and the external debt was 23 percent of GDP. Since 97 percent of thecountry’s external debt was concessional debt from multilateral institutions, including theWorld Bank and Asian Development Bank, the debt service payments were less than 2
percent of total exports and services.
Table 5. Key economic indicators of Vanuatu
Indicators
Annual Growth Rate
(percent)
Per Capita Income
Growth Rate (percent)Govt. Revenue(percent of GDP)
Govt. Expenditure(percent of GDP)
Overall Fiscal Balance(percent of GDP)
Gross Domestic
Investment(percent of GDP)
Gross National
Saving(percent of GDP)
Inflation (percent)
Growth rate of Import(percent)
Growth rate of Expons(percent)
Currrent Account Balance(percent of GDP)
Foreign Direct Investment(US Million Dollars)
External Debt/GNP(percent)
Debt/Service Ratio(percent)

Average
1980-1990

1991

1992

1993

1994

1995

1996

1.4

4.4

1

4

2.6

3.2

3

1

1.5

-1.7

1.3

0

0.7

0.6

NA

24.5

24.7

23.3

25.7

26.5

26.4

NA

38.4

33.4

31.5

38

37.5

38.3

NA

-13.9

-8.7

-8.2

-12.3

-11.1

-11.9

32.3

35.5

34.8

34.2

NA

NA

NA

7.2

7.7

7.5

9.5

NA

NA

NA

NA
NA

6.4
-16.0

4.1
1.2

3.6
8

2.5
2.6

2.3
7.2

2.5
8

NA

-3.2

30.2

-4.2

10.1

13.2

6.7

NA

-10.8

-9.9

-9.7

-9.9

-8.5

-8.7

13

25

26

27

30

25

NA

NA

22.8

23.2

24.8

24.7

NA

NA

NA

1.4

1.3

1.4

1.6

1.5

0.7

Sources: Asian Development Bank (1996)
World Bank (1996)

Gross domestic investment, as a proportion of GDP has been quite high, averaging at 35
percent each year and about 50 percent of this has been government investment. Since thepublic investments have been in projects of long gestation nature, the benefits have not been
immediately felt. However, it has been estimated the capital output ratio is approximately
10, which is very high by any standards. This raises the question about efficiency ofutilisation of funds which went into such projects, although these funds came from externalsources without creating any budgetary difficulties. The association of investment andgrowth has remained doubtful.
Simultaneously with a decline in external aid, from US＄55 million in 1991 to ＄45
million in 1995, especially in regard to withdrawal of recurrent budget support, as well as

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

15

technical assistance in terms of experts services and teachers from the British and metropolitan powers, there was a new disturbing trend observed in government’s departure fromthe prudent fiscal policies. The recurrent budgets were no longer in balance from 1995 andthe capital budgets were in deficit and the gaps were sought to be bridged by domestic
borrowing under the Special Project Implementation Schemes. Most of the projects werepoorly appraised and were not viable as they were politically motivated.

Domestic borrowing was found necessary because of the inelastic nature of the tax
system, which has been deliberately adopted by the country. There is no direct taxation of
any kind either on individuals or companies in regard to income or profits with a view tomaintaining the tax haven status. Therefore, the government has to rely upon indirect taxes
comprising those on international trade and tourism and a domestic turnover tax of 4
percent, which contribute 75 percent of total domestic revenue, as well as fees such as thoseon company registration and business licenses which contribute the rest. Import duties havealready reached a high at an average at 37 percent on consumer goods, 23 percent onintermediates, 11 percent on capital goods and 151 percent on fuel and 21 percent on
automobiles. In addition to import duties, export duties are levied at 3 percent on mostgoods including copra, beef and coffee, with higher rates on timber and shells. Taxes on
tourism include 10 percent hotel tax and departure tax. Any further maneuverability within
the current tax system is limited. Further, as a member of the World Trade Organisation,
Vanuatu is under obligations to revise its tariff system and thereby its tax structure, tomaintain its current revenue levels.
In the context of a strong commitment to retain the current system and not to introduce
direct taxation of any kind under the fear that it might scare away the OFC institutions,4 tax
reforms have to be effected within the present system. The government is aware thatreforms have to be not only with respect to raising revenues but also with economies in
expenditures in the public sector. While realising these requirements, the politicians felt that
cutting down the size of the civil service would be sufficient. But the remedies have to bemuch more comprehensive.

The civil service in Vanuatu is smallest in comparison with the rest of the SPICs: Only
3 civil servants per hundred country inhabitants as compared to 18 in the Cook islands, 8
in Tuvalu and 6 in Fiji (ADB 1993). On the other hand, the political wing requires immediate attention. The size of the cabinet has been constitutionally fixed at 20 percent of total
number of members of parliament. Presently, there are 12 ministers in the cabinet and each

4 The fear is baseless as most of the tax haven countries have followed the practice of exempting the OFCs fromdirect taxation while subjecting the citizens and local companies to income and company taxation without
experiencing discontinuance of OFC activities. It appears that the present system of taxation will continue inthe medium term, and reforms if any have to take place within the current tax structure.

16South Pacific Study Vol. 19, No. 1-2, 1999

minister brings three deputies who have no constitutional status and hence are not accountable to the parliament, from their own parties and they are designated as first, second andthird secretaries. They wield considerable power, besides enjoying full perks of the minister, with salaries and housing and chauffeur driven cars. With political instability contributing to four changes in the government in a limited period of two years (1996 -1998), four
sets of new cars and four sets of furniture and appliance, have to be imported and theexpenditure is substantial. Looking to the smallness of the country, questions are asked
whether a size of the cabinet with virtually a total number of 36 members is needed; andwhether the size of the cabinet be reduced to 6 or less. These issues fall under the categoryof governance issues which are treated in detail elsewhere (Jayaraman 1998b).

Vanuatu’s public enterprise sector (Table 6) consists of departmentally run undertakingsof commercial nature such as livestock farms which compete with private sector ranches
and cocoa and coffee plantations, statutory bodies set up under parliament acts such as
Vanuatu Commodities Marketing Board (VCMB), which has the exclusive right in marketing exports of copra and kava, and Development Bank of Vanuatu (DBV) for assisting
indigenous entrepreneurs with loans and National Bank of Vanuatu (NBV), a commercialbank and Air Vanuatu, an international airline and Van Air, a domestic airline. Besides
these, the government has got equity interest in several companies ranging from beer
production to tour operations.
Public enterprise reforms consist of (i) divesting all shares interests in all companies inwhich government has minority interest, so that they can be run better if left to private
sector; and (ii) rationalising the structures of statutory bodies such as by combining DBV
and NBV into a single entity and government companies such as Air Vanuatu and Van Air
into a single company. Disbanding of the VCMB, which is the last of the marketing boardsin the SPICs, is a difficult decision. It is being argued that the Vanuatu economy still needssome state intervention in agriculture sector from a balanced regional development point ofview, since the remote islands still depend upon cash earnings from copra exports. The only
solution in the short run appears to be is to improve the financial and management operations of VCMB so that the annual subsidies are transparent and minimised.
Privatisation process is under way for some of the government companies andrationalisation process will understandably take time as the politicians would find loss ofopportunities, being chairmen and members on the board of the fully owned corporations
and the associated perks and opportunities for personal gains and influence. However, thegains are clear to be seen in terms of less recurrent expenses in terms of subsidies and otherperiodic bailing out expenses of the continuously losing enterprises and consequent reduction budget deficits, giving rise to emergence of public sector savings. Further, thesesavings would enable to undertake quality government investments in health and education
towards improvement of skills contributing to human capital formation. In the context ofdecreasing foreign aid, public sector savings have to be stepped up and one clear way is tominimise involvement in activities which can be left out to the private sector for more

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

17

efficient operations.
Table 6. Commercially oriented enterprises
Fully Owned Companies
Air Vanuatu
Van Air
UNELCO (management contract)
Tour Vanuatu

Commercial Statutory Bodies
Vanuatu Commodities Marketing Board
National Housing Authority
Development Bank of Vanuatu
National Bank of Vanuatu

Commercially Oriented Government Activities
Drainage
Printing and Stationery
Public Works
Ports
Marine Fleet
Forestry
Government Stores
Government Garage
Village Fisheries Projects
Civil Aviation
Livostock Projects, Abattoirs
Postal Service

Commercially Oriented Companies Partially Owned
Bel-Mol Cattle Company
Metnesel Estates Limited
Melanesian Shipping Lines
Mifala Holdings Limited
New Resources Limited
PacificTextiles Limited
Port Vila Fisheries Limited
South Pacific Fishing Company Limited
Vanuatu Fish Investment Company Limited
Vanuatu Tropical Products Limited
Vanuatu Livestock Development Limited
Vanuatu Abattoirs Limited
Vanuatu Brewing Limited
Vanuatu Coconut Products Limited
Telecom Vanuatu

Source: Asian Development Bank (1997)

Public utilities in regard to power and water supply are in the hands of a private sector
company, Union Electric de Vanuatu (UNELCO), a subsidiary of a Paris based enterprise
under a management contract of 40 years which expires in 2011. Although the standard ofservice is highly regarded in the whole region as the best, the power tariff rates are considered the highest (Table 7). Similarly, the phone rates, charged by Telecom (a joint venture) are also the highest in the region. Although efficiency is certainly a desirable criterion,
the investors both existing and potential, find the tariffs unreasonably high. Although the
management contract agreements have conferred powers on the government to monitor andregulate the public utilities, they are hardly exercised. The chairman of UNELCO is normally a politician appointed by the government. 5 The board does not have any official fromthe ministry of finance which is charged with administration of public finances.
Reforms are required to set up a unit in the ministry of finance for monitoring theoperations of all public enterprises and public utilities. The unit will also oversee theprivatisation activities and advise the minister on all policy decisions. Considering thelimited availability of skilled civil servants with expertise in financial matters, there is noneed to set up any new body as the existing organisational structures can be strengthened
with appropriate technical assistance support from the international institutions who are
involved with public sector reform formulation and implementation.

18

South Pacific Study Vol. 19, No. 1-2, 1999

Table7. Comparison of Pacific Island electricity costs, February 1995
Country

US＄

Fiji(Domestic)

0.174

Kiribati(Domestic)

0.239

Papua New Guinea(Domestic＞100kWH mo)

0.160

Solomon Islands(Domestic)

0.131

Tonga

(All)

0.266

Vanuatu(Domestic＞121kWH mo)

0.345

Western Samoa

(All)

0.165

Source: Pacific Power Association, 1995

Cost of labour (Table 4) is very high relative to productivity. One of the reasons is thehigh subsistence living in the rural sector which sets the reservation price. Rural households
are not prepared to supply labour unless equivalent money wage is paid. Secondly, highimport duties with an average of 37 percent on consumer goods, which are relied upon for
raising government revenues in the absence of direct taxation, have pushed up the cost ofliving in urban areas. The large foreign aid in the past was also partly responsible forgovernment consumption which has driven up costs of labour in the formal sector. Other
reasons include the government’s minimum wage law, compulsory contribution at 3 percent
of wages by the employer to the provident fund, severance pay requirements, restrictions on
employment of expatriate skilled labour and increased localisation by employing a higher
number of unskilled local labour at greater costs have all resulted in high production costs.
Tax reforms including the introduction of a more neutral value added tax (VAT) would
contribute to resource mobilisation by lessening the current reliance on import duties.
Reduced tariffs on imported goods with a duty drawback system built in VAT are likely tolead to reduced price levels of consumer goods. Combined with tax reforms, greater enforcement of tax compliance, less number of exemptions and reduced discretionary powerof finance minister to grant exemptions would also lead to increase in revenue collection
and contribute to streamlining of and reduction in other indirect tax rates such as fees andcharges, which are today passed on to consumer. These will have a long term impact on
wages and contribute to easing real wage costs. Further, improvements to skills of workforce are urgently needed in terms of investments which would contribute to human capital.

5 In fact an ousted prime minister was given this plum job by his successor so as to get rid of him from active
politics. The perks of the job are considered to be the highest in the country and much more than what theprime minister would have, as the quarterly board meetings are reportedly held in exotic places, including Paris
which is the company’s headquarters.

JAYARAMAN : Private Sector Development and Competition in the South Pacific: A Case Study of Vanuatu

19

Despite a large number of banks and financial institutions, and the absence of any intervention in determining the interest rates by the Reserve Bank of Vanuatu, the spread
between the interest rates on deposit and lending is high, ranging between 8 to 10 percent.
This spread seems inexplicable in the context of high component of quasi money in the
broad money aggregate. The availability of such large financial savings has not led tonarrowing of the spread. The reasons attributed are the same as we noted in the last section:
the high cost of bank operations, high risks involved in lending, and lack of collateral
security for loans when only cash flows are considered for loan approval, non-availabilityof land as collateral in the face of land tenure problems and absence of good projects.
Appropriate interest bearing instruments have to be developed for the commercial banks
to place their excess reserves, which will reduce the cost of holding excess liquidity. This
will also enable nominal interest rates to rise for attracting deposits and reduce the spread.
Increased competition among the existing number of commercial banks will be necessaryby opening the banking sector with liberal grant of licenses, and this will contribute to break
the present oligarchic competitive conditions.

The land tenure problems causing considerable hurdles for long term investment in land
intensive private sector operations are quite similar to the ones observed in other SPICs.
Some innovations have been employed to circumvent the issues surrounding long termleases. For example, enterprising exporters of expatriate origin have concluded informal
nucleus type arrangements with land owning communities for growing squash for exports
during its off-season in niche markets in Japan. Under these arrangements, the exporter
arranges seed, technical advice and crop loans from DBV to the landowners and buys thecrop and exports it. Deductions towards expenses including repayment of crop loan from
DBV are duly effected from the payments to squash growers. These arrangements haveworked out successfully. However, for long term investments such as tourist resorts in Port
Vila and Luganville and in outer islands the problems remain.
The problem of land tenure issues also haunt the government from time to time. The
custom law is superior to manmade laws. What was considered a once-for-all settled issue,
the land acquisition for the municipal area of Port Vila is being raked up from time to time,
especially just prior to national elections once in four years, when the politicians seize
opportunities to exploit disgruntled elements. The original land owning clans have been
moving up the courts for annulling the earlier settlement under which they were paid cash
compensation for purchase of land for constructing roads and public buildings and declaring
the land as municipal area falling under the Port Vila urban area. The idea behind is tonegotiate some more favourable terms and conditions under which they can have a new
system of annual rents which can be raised each year reflecting price level changes orincreased cash compensation. These experiences do not inspire any confidence to handle
these thorny issues of property rights within the current structure of customary land tenure
and custom laws vis-a-vis the legal documents of doubtful enforcement.

20South Pacific Study Vol. 19, No. 1-2, 1999

One institutional solution has been proposed under which all customary land would be
brought under one statutory body on the lines in Fiji, where the Native Lands Trust Board
acts on behalf of the land owning communities and negotiates leases and supervises theenforcement of leases and acts as an intermediary between the two parties.

3. Conclusions
Deregulation of economic activities in the otherwise public sector dominated SPICs havereleased enormous energies from private entrepreneurs. Dismantling old tariff regimes andthe efforts to fulfill the membership obligations of World Trade Organization have also sentright signals to private sector. Combined with these developments, special packages of
incentives for attracting new investments have also been well received. Although immediate
responses are from foreign investors to take advantage of these new opportunities, affirmative action in terms of greater credit support and other special treatment is expected toencourage native entrepreneurial initiatives. Recent evidence suggests that the indigenous
private sector efforts will be forthcoming if properly encouraged.
Governments in SPICs have also embarked upon reforms to downsize the public sector
by aiming at not only in reducing the size of the civil service but also winding up uneconomical and financially burdensome public enterprises. Although resistance to large scale
privatisation of commercial enterprises in the public sector is in evidence as the politicians
are likely to lose opportunities for influence peddling and earning rents, increased awareness of mobilising public sector savings in the face of grim prospects of reduced external
aid have made the decision makers conscious of the need for reforms.
However, privatisation by itself is not a panacea for all ills. Market forces have to be
facilitated to work freely to promote completion. There are barriers of several kinds tocompetition. Some of them are unique to the SPICs, such as those we see in regard to land
tenure. Sooner or later solutions have to be found.
However, there are possibilities of making mistakes. These might include decisions to
privatise public utilities which are natural monopolies. Private sector monopolies, unlessregulated properly, may be harmful to competitive conditions. Appropriate interventions
from the state are needed to exercise regulatory control on monopolistic units. Privatisationis only one element of strategy to promote competition and that is not an end in itself.

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(Accepted 27 July, 1998)