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Swimming with the Tide

By C.L. Cheshire

April 2010 (MC #81) Business Economics

Introduction

At a luncheon in Honolulu, a representative of the Bank of Hawaii told the story of the development of the Nikko Hotel on Saipan. A group of Japanese investors provided money to purchase a site for the hotel. After the hotel was built, the original landowners went to court to contest the purchase of the land. The court ruled in their favor and voided the sale of the land. Since the Nikko trial there had not been another major hotel project on Saipan financed by Japanese investment.

At the same luncheon, a representative of the Outrigger Hotel chain with hotels throughout the Pacific described how Outrigger goes into a location to develop a hotel. Before initiating a project on a Pacific island, he said, Outrigger takes the time to get to know the local business community to find out who is reliable and will be a dependable partner. Outrigger then works with its local partner to secure the necessary agreements to obtain the land for its hotel. The chain has never had any problems with landowners or traditional land tenure laws in any of its Pacific island hotel projects, he said.

The Asian Development Bank has funded the publication of several reports calling for a program of reforms to create a more favorable investment environment in Pacific Island Countries. These publications have argued that unless there are institutions in the Pacific Islands such as clear, enforceable land tenure laws, consistent enforcement of contracts by the courts and secured lending, the region will not be able to attract the investment needed to develop its private sector. Yet, as the example of Outrigger Hotels shows, successful investments are being made in the region despite its weak institutions. In fact, ever since foreign trade was introduced into the Pacific Islands in the 18th century the Pacific Islands have always been able to attract foreign investment. Companies like Outrigger are using the same development strategy that has been successfully employed for more than two hundred years despite the difficulties of working in a region where costs and risks are high and the formal institutions (banks, courts, government agencies) are inefficient and unreliable. All of this suggests that we need to look beyond a particular set of policies and formal institutions and examine more closely the investments that have occurred in the region to understand what has caused these investments and what role formal and informal institutions have played in supporting them.

Reform of Local Institutions

The most comprehensive critique of economic institutions in the Pacific Islands to date is an ADB publication entitled Swimming Against the Tide?: An Assessment of the Private Sector in the Pacific. It concludes by calling on Pacific Island governments to support private sector development by:

  • Fostering financial sector development so that credit is more available for business development;
  • Clarifying land rights and modifying them with respect to cultural preservation and the development of land markets;
  • Reducing the role of the government in the economies of the region;
  • Revamping the regulatory regimes so that business development is less constrained and monopolies are prudently regulated;
  • Providing assistance to small-scale rural enterprises.

This emphasis on the reform of formal institutions follows Nobel laureate Douglass North, who has argued that getting the formal institutions right is crucial because some institutions create incentives that produce economic development while others undermine it. North observes that developing countries, like the island states in the Pacific, tend to foster institutions that promote "re-distributive rather than productive activity." In other words, the use of money to foster personal relationships takes priority over using it to make the economy grow. This is particularly true in some of the states in the Pacific where status and connections are important and where commercial opportunities are distributed within family/political networks. Many of the business leaders in the Pacific, for example, owe their success to their positions in ventures that are owned and subsidized by the state. An analysis of the public institutions in the Republic of the Marshall Islands shows that the RMI government supports 19 state-owned enterprises (SOEs), many of which are completely dependent on the government, not only for capital funding but for operational funds as well. But what is most 're-distributive' about Pacific Island governments is that government employment, which is often an extension of the island patronage system, accounts for a disproportionate percentage of economic activity. Reports have been written calling for fewer government employees and smaller state budgets, but island governments have persisted in maintaining high levels of public employment.

One of the glaring defects in Swimming Against the Tide is that it does not acknowledge this history of resistance to institutional reform on the part of island governments. Hence, it does not adequately explain why island political leaders would break with their past practice and embrace the list of recommended reforms.

Historically, it has been the private sector in the Pacific, not elected officials, that has led the way in demanding institutions that support private sector development. In Hawaii, the call for land reforms in the early 1850s came from foreigners who hoped to profit from land speculation. In Fiji, the merchants supported Fiji’s first constitution as a tool to collect outstanding debts from white planters, and throughout the 20th century Indo-Fijian sugar farmers have consistently and effectively pressed for land reforms.

Only during the last twenty-five years has private sector led reform in Pacific Island states been the exception rather than the rule. Part of the reason for this is that the private sector in the Pacific is a relatively small part of island economies. Island governments are not dependent on the tax revenues that come from the private sector to fund their operations. Consequently, the private sector in these Pacific Island states, rather than being in a position to insist on pro-business institutions, must court the favor of the government to secure contracts for development projects and obtain various perks such as approval of loans from state owned development banks.

According to North, economic reform is less likely to come from officials tasked to administer top-down reform programs (because the benefits that come from maintaining the status quo give these same officials a compelling incentive to frustrate change) than it is from the gradual evolution of local, informal institutions. When we look at the Pacific, though, we find that the various bottom-up, grassroots strategies introduced there are also confronted with competing incentives. Despite repeatedly asking for programs and projects designed to provide them with private sector job opportunities, for instance, Pacific islanders consistently have chosen to pursue other sources of income such as local government jobs and out-migration. These alternative sources of income, along with remittances, have undercut the need for Pacific islanders to create jobs in their local private sector.

Nevertheless, remittances and government payroll have produced a relatively high level of consumption in the Pacific that has in turn created opportunities to develop new island businesses. As a result, island governments were persuaded to use their aid funds to develop entrepreneurship programs to create privately owned businesses that could recycle some of this income in the local economy. Island leaders were encouraged by the advocates for these small business development programs to look upon small business development as the engine that would turn Pacific islanders into small business owners who would create a vibrant private sector. Surveys showed, though, that before this could happen island entrepreneurs needed small business loans and management training and market information. To make up for the lack of capital, island development banks were funded to provide highly leveraged small business loans, but these loans only succeeded in saddling the entrepreneur with a burdensome and often unmanageable debt. To address the apparent lack of management skills, island governments funded training programs, but training alone could not address the problems inherent in doing business on a small island where local markets are quickly saturated and off-island markets are often inaccessible due to the lack of affordable transportation.

In summary, whether the programs and initiatives have been "top down" or "bottom up," efforts to stimulate private sector development in the Pacific Islands have been a general failure due to "path dependence"–that is, the persistence of existing institutions to preserve the status quo.

Looking Backward at Pacific Trade

Despite the current lack of private sector development in the Pacific, many of the Pacific Island states over the last two hundred years have dramatically transformed their economies so that they bear little resemblance to the communal, subsistence economies that the first European explorers witnessed. The Pacific Island states possess jet airports, modern communications, ports and harbors, electrical grids, paved roads, modern hotels and local manufacturers who export their products all over the world.

Two hundred years is a relatively short period of time compared to the time it took the European states and their colonies to bring about similar changes. How did this all happen so quickly? The role of long-distance trade was critical in the economic development of the Pacific. One can follow the development of Pacific Island trade from sandalwood, and beche-de-mer, through whale oil and copra, to sugar and coffee and finally to tuna, Tahitian pearls and tourism, with a few minor products along the way. The market opportunity for each of these products attracted traders from America, Europe and Russia who invested in those islands where these products could be obtained. This trade later attracted the interest of the traders’ respective governments, which made investments to secure the trade for their nationals as part of their global economic strategy.

Land. The institutions that were critical for long-distance trade were different from those that supported the development of local commerce in Europe and the land-based economies of their colonies in the Americas. For long-distance traders, land was not essential. It was more often a liability than an asset since it was difficult to secure and easy to lose. The trader needed only a relatively small site – space at the dock or along the road or a booth in the market. In the beginning of Pacific Island trade, the deck and hold of a ship were more than enough space for trading if the islands possessed a navigable harbor and an accommodating trading partner. The trader placed a premium on having the flexibility to shift from one trade good and one market to another as demand changed.

Labor was also a commodity. The trader himself employed relatively few people, only those needed to complete the trading transaction. In most cases, though, a trader did not deal directly with island workers. He left that to those from whom he obtained his local products. This production partner was expected to know the most effective 'currency' to motivate the local workforce. In the Pacific Islands this was land, food and status, all of which were controlled by the local elites. The trader, then, had to rely on his trading partner to provide both security and workers. From the perspective of the trader, the labor market could be reduced to one person. This was the case in Hawaii where Kamehameha, for a time, controlled all of the sandalwood trade. In Fiji and Tahiti there was more competition among the elites for control of the trade.

Markets. Just as the trader had to work through the local elites on the production/supply side of the trade, he also had to work through the elites on the market/distribution end of the trade as well. The market in which the long-distance trader sold his goods bears little resemblance to the classical economist's ideal market where products are sold to all comers at prices that are set by those in the market who are able to compare products as well as prices. The elites in foreign markets controlled the distribution of goods, local as well as foreign. The trading company had to work through a local agent who, in turn, worked through a local distribution network. The distribution networks had grown up over many decades and in some cases centuries. Each network amounted to an enormous sunken cost in time as well as expense that no outsider could easily match, much less improve upon. Because the costs almost always far exceeded the benefits, there was little justification or incentive for the trader to create a local distribution network of his own, but every reason to work through the much better informed and connected local distributors.

Partnerships and Contracts

Given the importance of forming partnerships–between the traders and their local producers, and between traders and their distributors–it is not surprising that the institution on which long-distance trade was built was the self-enforced contract. The trader's agreement with his suppliers and distributors had to be self-enforced because he was almost completely on his own. He was beyond the protection of the legal system of his home country and not always recognized legally in the countries where he traded. For the trader's agreements to be self-enforced, they had to meet the following five conditions:

  • The participants must gain each other's trust.
  • The participants must have an incentive to trade.
  • The participants must be able to meet their commitments as well as protect the trade from theft or attack;
  • The projected benefits from future transactions must exceed the gain from cheating in any single transaction;
  • The penalties for cheating or failing to meet a commitment must be severe such as termination of the contract or exclusion from future trade.

The incentives as well as the contributions of the participants in the trade agreement may be completely different: each party can be operating in a different value system and may employ skills, experience and assets that are foreign to the other party. As long as everyone involved can see a benefit from the contract, though, the complications that often occurred as a result of cultural differences could be addressed and overcome. They could also outweigh the incentive to cheat. For the early traders in the Pacific, there was a built in incentive to return for future trade because their ships could only hold so much sandalwood or beche de mer. For island chiefs, future deliveries of ships and guns made trade a valuable asset in the ongoing competition for status and control of island resources.

Early island trade was successful precisely because it was able to address and overcome what today are perceived to be the major barriers to private sector development-the lack of secure contracts and the prevalence of cheating; difficulty motivating and retaining island labor; the lack of Western production technology; the inability to penetrate and compete in foreign markets. The early traders overcame these barriers in an environment in which the formal institutions that we rely upon today to support and protect commerce–laws, courts, third party enforcement–were not only weak, but in most cases non-existent. Island trade relied on partnerships based on a set of incentives that were sufficiently advantageous to the traders, who had access to a global distribution system, and the island elites, who controlled the local natural and human resources.

The idea that markets had to be legally open and market opportunities equally available to everyone was totally foreign to early island trade. Early island trade was not hampered, reduced or slowed down by a lack of Western technology in the islands or a lack of understanding of foreign markets. The chiefs as well as their Western trading partners quickly overcame the information gaps on both sides of the trade through collaboration and a pooling of technology, experience, skills and knowledge. As a result, the chiefs never had to become international traders with agents in markets throughout the world and the traders never had to become island chiefs with traditional authority over island resources and island labor.

The Role of Island Trading Houses

The other institution, besides the self-enforced contract, that has played a significant role in the development of Pacific island economies has been the island trading house which grew directly out of the early trade. As the supply of sandalwood and beche de mer dwindled to a trickle the traders left agents in the islands so they could trade year round for the small lots of sandalwood and beche de mer as they came in. Some of these agents formed island trading houses replicating the trading houses in America, Australia and Europe that had sent them out to the Pacific. The trading houses in Honolulu became the crossroads of the Pacific and were supplied by regular visits from trading ships from all over the world. The Honolulu trading houses took delivery of furs and lumber from the Pacific Northwest, cloth and manufactured goods from London and Boston and traded with the chiefs for sandalwood and local produce. These trading houses stocked the same trade goods used by the earliest traders: guns, powder, tools, nails and cloth.

With the advent of whaling in the Pacific in the 1820s, the trading houses expanded to address the needs of the whaling fleet. They not only supplied the whaling fleet with equipment and produce, they also provided storage and shipping services so that the whalers could off-load their oil and ship it home without having to return to their home port. The model for these full-service operations–or factors as they were known in Hawaii–came from the Hanseatic town of Bremen by way of Heinrich Hackfeld who settled in Hawaii in 1849. Samuel Castle and Amos Cooke, who took over the missionary commissary in Honolulu as a private business in 1851 when the American Board of Commissioners for Foreign Mission withdrew from Hawaii, followed Hackfeld’s example. They were soon joined by Theo Davies, originally an agent for the American trading company, C. Brewer & Co.

The whalers did not begin to trade for coconut oil until the 1850s. It was a natural complement to the whale oil they were already collecting. They already carried the barrels to store it, and like whale oil it was very lucrative. One could trade 17 cents worth of tobacco for 3.5 gallons of coconut oil worth $3.50. Harry Maude, who provides the only detailed account of the early coconut oil trade in the Pacific, suggests that it developed on lines similar to the earlier sandalwood and beche de mer trade. At first, beachcombers and castaways acted as mediators between the whaling ships and the island chiefs who oversaw the production of the oil by island labor. Later, as the trade developed, resident agents remained in the islands to trade, collect and store coconut oil year round. These agents were dependent on the whaling ships to return and transport the oil to market.

Like the trading houses in Hawaii, the early coconut oil traders had to take the next step and create their own link to the market. Richard Randell in the Gilberts sailed to Sydney to arrange to have his oil picked up. When he arrived in Sydney, Randell had to form a partnership with a local merchant, Charles Smith. Smith agreed to provide trade goods, pick up Randell's oil and sell it, while Randell was responsible for the organization and management of the trade in the Gilberts, including the recruitment, employment and posting of agents throughout the islands. To secure the oil he needed from the islands, Randell had to rely upon the authority of the High Chief Baitke. In return for the chief's support, Randell, supported the chief and his family and acted as interpreter in their dealings with other Europeans.

In 1857, with the arrival in the Pacific of the large Hamburg trading house, Godeffroy and Son, the coconut oil trade in the Pacific changed from oil to copra. Godeffroy and Son established its headquarters in Apia in Samoa and began experimenting with various local products as potential exports. The process of drying coconut meat into chunks of copra was introduced by Godeffroy's agent, Theodor Weber. Copra took less time and labor to produce than coconut oil and could be shipped to Europe for processing into coconut oil with less spoilage. As a large trading house, Godeffroy had the means to accomplish throughout the Western and Central Pacific what Randell and Smith had been able to do only in the Gilberts. Independent island traders quickly saw the advantage of partnering with this large German trading house. After only a year operating as an independent coconut oil trader, Adolph Capelle in the Marshalls went to work for Godeffroy. Through this partnership Capelle obtained trading goods from Godeffroy and gained a reliable buyer with access to markets throughout Europe. Like Randell, Capelle used the authority of the local chiefs to harvest and process the copra. The laborers who dried the copra handed it over to the chiefs and were rewarded with a share of the trade goods as the chiefs saw fit. In this way the chiefs served as "economic brokers" for the traders.

The island trading houses in the Pacific in the nineteenth century provided several critical services that made the copra and sugar industries in the Pacific possible. First, they were a source of capital. Second, the trading houses were a source of technical expertise that figured significantly in the development of both sugar and copra. Through their links to the larger global market, the trading houses had access to technical information that was either not available in the islands or could not be obtained except at a cost the growers could not afford. Finally, the trading houses provided island producers with a link to the market. The trading houses possessed a network of associates and agents in markets where the trading houses were well known. These relationships proved invaluable when the trading houses made sugar and copra part of their business.

Contemporary Pacific Island Export Development

The gradual disappearance of sugar as a Pacific Island product over the last thirty years and the collapse of copra prices in the 1990s should not obscure the fact that both these industries were almost uniquely self-sustaining for over a hundred years. Yet the early history of these industries is rarely, if ever, invoked as a model for contemporary island export development. This is surprising since, as the sociologist Gary Gereffi has shown, the same partnership between local producers and distributors with links to the global market is being used today by developed and undeveloped countries throughout the world to bring them into the global economy. He calls these Global Commodity Chains. Examples of island-based commodity chains can be found in the agriculture and aquaculture industries in the Pacific. Hawaii papaya and Fiji fresh ginger and Tahitian black pearls and Marshall Islands giant clams demonstrate more clearly how commodity chains work as partnerships in the Pacific.

Hawaiian Papaya and Fijian Ginger

The history of the Hawaii papaya growers’ export partnership with AMFAC, the direct descendant of the company originally begun by Heinrich Hackfeld in 1850, and the development of fresh ginger as an export product in Fiji are two good case studies of export development. Both case studies make it clear that the impetus for these successful export industries was a partnership between local producers and an individual or company with links to the global market. In Hawaii, AMFAC partnered with the Hawaii papaya growers to export their papayas on the U.S. mainland. This gave the papaya growers the benefit of AMFAC's size as well as its network within the U.S. food market where AMFAC was well established as a distributor of Hawaiian sugar and pineapple. In Fiji, the export of fresh ginger production began as a joint venture between the local fresh ginger growers and a representative of a New Zealand confectionary company who connected the ginger growers with a large West Coast importer in Vancouver.

Tahitian Pearls

Tahiti's black pearl industry is another example of a Pacific Island export industry that was built on a partnership between a local producer and a distributor positioned to penetrate a well developed global market. Jean-Claude Brouillet, one of the pioneers of Tahiti's black pearl industry, confronted serious barriers when he tried to market his first pearls. Brouillet spent several years unsuccessfully marketing his pearls before he was put in touch with Salvador Assael, the premier pearl dealer in New York at the time. Assael had Brouillet's pearls transformed into fine jewelry and displayed in New York's most exclusive jewelry houses. Brouillet and Assael eventually developed a formal partnership that gave Assael exclusive rights to sell Brouillets pearls in the world market while Brouillet retained the exclusive right to sell his pearls in Tahiti.

After Brouillet's pearls were introduced in New York, Japanese pearl manufacturers saw the need to secure their own source of Tahitian pearls. They made an agreement with Robert Won, another successful Tahitian business man who had developed his own pearl farm in Tahiti. In the 1980s and the 1990s the demand for Tahitian pearls grew very rapidly, with the Japanese being the primary buyers. As production increased, so did the transfer of technology to Tahitian pearl farmers. The Tahitian pearl industry became a leader in hatchery development and the use of x-ray, coated nuclei, and cleaner-boats.

Marshall Islands Giant Clams

An East West Center report by R. Uwate was published in 1984 on the development of mariculture in the Pacific in which the author observed that almost all of the aquaculture development efforts during the previous thirty years had fallen far short of their goal. The usual scenario, as he described it was: "An overzealous biologist or uninformed bureaucrat often pushes for aquaculture development even when it is neither practical nor makes the best use of resources. The venture that results usually cannot market its product at a profitable level. The firm develops cash flow problems and subsequently folds... An aquaculture project is usually developed by experts who are brought in for a few years. When they leave, the project folds for lack of interest and/or lack of local technical know-how."

In the very same year, an article was published documenting the successful mass culturing of giant clams at the Micronesian Mariculture Demonstration Center in Palau with the same enthusiastic claims for the economic potential for giant clams that Uwate had been so critical of. The enthusiasm for giant clam aquaculture was picked up by the popular media, which published articles encouraging Pacific island governments to support giant clam mariculture. Soon, virtually all of the Pacific island states, with support from a variety of development organizations, were funding giant clam mariculture projects. But, twenty years later, Cheng Sheng Lee, Director of the Center for Tropical and Subtropical Aquaculture (CTSA) in Hawaii acknowledged that: "After... years of intensive effort by CTSA to develop and transfer technology, the production of giant clams... has yet to make any significant contribution to the local economy."

Like the early sugar growers in Hawaii and Fiji, those who supported the giant clam industry underestimated the difficulty of penetrating the giant market. Early test marketing of farm raised clams in Hawaii, Guam, and Saipan produced discouraging results. Subsequent market research identified a rapidly growing demand in the marine aquarium market for live, two to three year old giant clams. Growing giant clams for the marine aquarium market would require clam farmers to shift to a different species of giant clams. They would also need to locate their farms close to airports to minimize handling and shipping. Both changes were potentially costly, but development funds were still available to underwrite a second effort to create a giant clam industry. This second attempt, however, also ended in frustration as the farm-raised giant clams were unable to compete with less expensive giant clams that were being harvested from the wild for the aquarium market. After this second failure, the development agencies and their client governments ceased to fund giant clam aquaculture, and the farmers who had received clams through the project stopped growing them. The only exception was the privately owned giant clam farm that was established by Robert Reimers Enterprises (RRE) on Long Island in the RMI.

RRE was founded by Robert Reimers, a Marshallese who was trained as a boat builder by his uncle and worked for the Japanese between the two World Wars managing stores on Jaluit and Wotje where the Japanese traded for copra. After World War II, Reimers formed a partnership with an American from Hawaii he met at the shipyards who supplied him with specialty goods from Hawaii. By 1950, he was able to obtain a commercial bank loan (the first commercial loan given to a Marshallese) to build a large general store with freezer capacity capable of storing container loads of frozen food. As RRE grew, the business hired hundreds of Marshallese.

Reimers’ decision to raise giant clams was prompted by the publicity it received as a low tech, low cost, profitable business. During the sixteen years (1986-2002) that RRE was involved in growing giant clams, the company experienced the same setbacks as the rest of the giant clam industry in the Pacific. RRE made the costly change from growing giant clams for food to growing them for the marine aquarium market and opened a second farm on Long Island near the airport. When the farms did produce marketable clams, transportation became a problem. Continental Airlines, the only airline that served the RMI, repeatedly bumped RRE’s shipments of giant clams due to a lack of freight space. It is estimated that during the period that RRE developed and operated its clam farms it spent well over a million dollars on its giant clam operation. Except for a few years when RRE was able to grow and sell giant clams successfully it covered its losses from its giant clam operation with income from its other businesses.

In 1998, RRE finally found a reliable manager who could produce clams consistently. By attending trade shows in the US, he was eventually able to find reliable buyers. It took more than a decade for giant clams from the Marshall Islands to penetrate the market, but today the brightly colored, electric blue and green clams that the Marshalls produces are prized by marine aquarium hobbyists throughout the world. Once these clams had found a place in the market, RRE's sales increased rapidly. In 2002, Oceans Reefs and Aquariums (ORA) bought RRE's Long Island farm. Meanwhile, production continued to increase. ORA exported over 18,000 giant clams from the RMI in 2005 and recently announced plans to expand its operation in the Marshall Islands to use the remote lagoons of the outer atoll islands for grow out areas for their giant clams and cultured live corals.

Conclusion

Despite the current focus on reforming the formal institutions in the Pacific–lending institutions, land tenure laws, government agencies, court system–as the key to private sector development, the two institutions that have been the most instrumental in the development of the private sector in the Pacific have been and continue to be the self-enforced contract and the island trading house. This was true in the nineteenth century when trade began with sandalwood and beche de mer and later as sugar and copra became the backbone of island economies. The early trading partnerships between island producers and global traders gave island trade the security, reliable work force, capital, technical expertise and access to foreign markets that were essential for its success. Island trading houses developed the copra industry in Fiji and Micronesia, turning a locally consumed subsistence crop into an international commodity by opening up markets in the United Kingdom and Germany. Trading houses also provided the emerging sugar industry in Hawaii the time and the resources necessary to mature into a profitable industry that in turn provided the foundation for still other industries such as tourism and shipping.

Self-enforced contracts between local producers and global distributors along with island trading houses continue to be at the cutting edge of Pacific Island private sector development. Their influence is evident in all of the important industries that have developed in the Pacific in the last fifty years–from papaya and cut flowers in Hawaii and pearls in Tahiti to giant clams and live coral in the Marshalls to international hotels in Fiji and Guam. These examples of successful export should serve as models as well as foundations for future developments.

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