presentation - Kellogg Institute for International Studies

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presentation - Kellogg Institute for International Studies

LATIN AMERICA IN THE

GLOBAL ECONOMY

“SUCCESS STORIES FROM

INSIDE AND OUTSIDE THE

REGION”

April, 2005


Index

I. FACTORS BEHIND LATIN AMERICA’S

GROWTH PERFORMANCE

II. MEXICO AND CHILE’S COMPARATIVE

PERFORMANCE

III. THE CASE OF MEXICO

IV.FINAL REMARKS


Log of per-capita GDP in 1966 dollars

Why has Latin America fallen behind?

PPP adjusted per capita GDP: Weighted Regional Averages

Source: Penn World Tables 6.1. IMF’s IFS from 2000 onwards

Latin America

Argentina Jamaica

Bolivia Mexico

Brazil Nicaragua

Chile Panama

Colombia Paraguay

Costa Rica Peru

Ecuador Venezuela

El Salvador Uruguay

Guatemala

European Four

Greece

Ireland

Portugal

Spain

East Asia

Hong-Kong

Malaysia

Singapore

South Korea

Taiw an

Thailand


Why has Latin America fallen behind?

It is probably fair to say that each of these regions based its

development strategy on different paradigms:

During most of this period, Latin America based its growth strategy on an

inward-oriented industrialization. However, during the eighties this region

switched to a more free-market, competitive paradigm.

East Asian growth strategy was fundamentally outward oriented. Among

others, the growth strategy of this region entailed public interventions to

promote savings and human capital formation, as well as the activity of

sectors that exhibited positive externalities.

Growth in the European Four was boosted by transfers from other European

countries and by the adoption of the institutions governing economic

activity that prevailed in the rest of Europe.


Why has Latin America fallen behind?

We can think of three levels in terms of the interrelated determinants of

the relative performance of these regions:

Immediate determinants of growth: Savings and investment rates.

Structural determinants, such as macroeconomic policies and open

economy orientation.

Deep, institutional factors, which influence the workings of the market

economy.

In what follows, I will summarize the role each of these determinants

has within the growth process and compare Latin America with East

Asia and the European Four in terms of these determinants.


Institutional

Framework

Immediate, Structural and Deep Determinants

of Growth.

Macroeconomic

Stability

Financial Market

Depth

Pro-Competitive

Orientation

Openness

Determinants of Growth

Public Policies to

offset Market

Imperfections

and Externalities

Savings

Investment

Growth


Institutional

Framework

Immediate, Structural and Deep Determinants

of Growth.

Voluntary Savings (endogenous)

Macroeconomic

Stability

Growth

Development and

Regulation of

Financial Markets

“Involuntary” Savings (exogenous)

Market Failure

Absence of Complete

Ricardian Equivalence

External

Savings

Domestic

Savings

Investment in

Tradable Sectors

FDI: Technology

Transfer

Investment in Non-

Tradable Sectors

Infrastructure

Human Capital

There is a role for public policies

to induce long-term savings to

finance High Social Return

Projects

Social Security Social

System

Public Saving


Overview of growth-related indicators

Source: Penn World Tables 6.1. and IMF’s IFS|


Savings and Investment

The rates of investment and domestic saving rates have been

lower in Latin America than in other faster growing regions.

Gross Capital Formation

(As percentage of GDP)

Source: Penn World Tables 6.1

Domestic Savings

(As percentage of GDP)


Macroeconomic Policies

Latin America has not completely overcome its fiscal problems and still exhibits

higher inflation rates than other regions. The export orientation of other regions,

particularly Asia, contrasts with the relatively closed Latin American economies.

Federal Government Balance

(As percentage of GDP)

Source: Penn World Tables 6.1. IMF’s IFS from 2000 onwards

Inflation Rates

(In percent)

Trade Openness

(Exports plus imports

as percentage of GDP)


Infrastructure in Physical and Human Capital

Latin America exhibits important lags in the creation of basic

infrastructure, as compared especially with East Asia

Paved Roads

(Average Annual Growth)

Electricity Generating Capacity

(Average Annual Growth)

Source: World Dev elopment Report 1994.

Electricity Production

(Average Annual Growth)

Railroads

(Average Annual Growth)

Telephone Lines

(Average Annual Growth)


Infrastructure in Physical and Human Capital

Educational indicators in Latin America also show an insufficient

accumulation of human capital, as compared to other regions.

Complete Higher Secondary

(% of 25 years or older)

Average Schooling

(25 years or older)

Source: Barro-Lee(2000) and World Dev elopment Report 2003, World

Bank.

Complete Higher Education

(% of 25 years or older)


Quality of Institutions

Latin America lags behind East Asia and the European Four with respect

to the quality of institutions

Source: Kauffman, Kraay and Zoido-Lobaton (1999ab), World Bank. Normalized indices, with zero mean and unitary standard dev iation.


Challenges ahead for the region as a whole

To some extent, the poor results from reforms of the past 15 years

reflect inadequate and insufficient implementation.

There is also a need to extend the reform effort with second generation

reforms and, in particular, with a strengthening of institutions.

When there are several distortions in an economy, the removal of one

of them could enhance the effect of the remaining ones. Thus, special

care must be taken to apply an appropriate sequencing of the reforms.

This is a very relevant factor that may determine their overall effects on

welfare.

Currently, however, policymakers face a less favorable political

environment to sustain the reform effort: reform fatigue and the

complexity of forming reform-supportive political coalitions limits the

speed with which the reform process can be advanced.


Index

I. FACTORS BEHIND LATIN AMERICA’S

GROWTH PERFORMANCE

II. MEXICO AND CHILE’S COMPARATIVE

PERFORMANCE

III. THE CASE OF MEXICO

IV.FINAL REMARKS


Mexico and Chile Have Been Taken Frequently as

Reform Success Stories Within the Region…

Mexico and Chile were considered exemplary reformers during the era

of first-generation reforms in Latin America.

These countries followed a similar paradigm in terms of the procompetitive

approach of their reforms. These reforms generally

included:

The opening up of the economy to goods and capital flows

Macroeconomic stabilization

Reforms to the financial sector

Pension system reform

Deregulation

Privatization

Competitive provision of inputs through networks


Mexico and Chile Have Been Taken Frequently as

Reform Success Stories Within the Region…

However, as we will see, there are two fundamental differences

between Mexico and Chile’s reform process:

Chile attained macroeconomic stability and undertook most reforms more

than a decade before Mexico.

Furthermore, the reforms in Chile implied deeper structural changes in the

workings of the economy than in the case of Mexico. In particular, Chile has

achieved a favorable institutional framework, while Mexico still lags behind

in terms of the quality of its institutions. This may be a reflection of an

overall more pro-competitive stance in Chile’s policymaking.

In this part of the presentation, I will focus on those indicators that

make these differences clear. These include:

Savings and Investment

Macroeconomic policy indicators

Human capital formation

Quality of institutions


Mexico and Chile Have Been Taken Frequently as

Reform Success Stories Within the Region…

Trade liberalization

Macroeconomic stabilization 1

Liberalization of the financial sector

Regulatory reforms to the financial sector

Central bank independence

Pension system reform

Deregulation 2

Privatization

Pro-competitive policies

Competitive provision of inputs through networks

Mexico

(mid 80’s)

(late 80’s)

(mid 80’s)

(1997)

(1994)

(1997)

?

(early 90’s)

?

?

Chile

(mid 70’s)

(mid 70´s)

(mid 70´s)

(early 80’s)

(1989)

(1981)

(late 70’s)

(mid 70´s)

1/ Mexico first attained macroeconomic stability in the late eighties with the “pacto” programs, although full stability

was only achieved after the 1995 crisis. Chile undertook macroeconomic stabilization in the mid-seventies,

although it also suffered a financial crisis in the early eighties.

2/ Chile’s deregulation strategy was contained in the “seven modernizations” of the late 70’s and early 80’s.


Savings and Investment

The rates of investment and domestic saving rates in Mexico and Chile did not

exhibit a better performance than the rest of Latin America until the eighties.

After the eighties, Chile’s savings and investment rates increased significantly,

as compared to Mexico and the rest of Latin America.

Gross Capital Formation

(As percentage of GDP)

Source: Penn World Tables 6.1. IMF’s IFS from 2000 onwards

Domestic Savings

(As percentage of GDP)


Macroeconomic Policies

Chile achieved macroeconomic stability in the mid-70´s, while Mexico kept on

exhibiting macroeconomic imbalances until 1995.

Mexico and Chile currently exhibit a much stronger outward orientation than

the rest of Latin American countries, on average. Chile’s trade liberalization,

however, was undertaken much before Mexico’s.

Federal Government Balance

(As percentage of GDP)

Inflation Rates

(In percent)

Source: IMF. SHCP and Banco de México for Mexico. Source: IMF.

Trade Openness

(Exports plus imports as

percentage of GDP)


Infrastructure in Human Capital

Complete Higher Secondary

(% of 25 years or older)

Average Schooling

(25 years or older)

Source: Barro-Lee(2000) and World Dev elopment Indicators, World Bank.

Complete Higher Education

(% of 25 years or older)


Quality of Institutions

Chile exhibits much better institutional quality indicators than the rest

of Latin America, while Mexico tends to exhibit similar or worse

institutional indicators than the rest of the region.

Source: Kauffman, Kraay and Zoido-Lobaton (1999ab), World Bank. Normalized indices, with zero mean and unitary

standard dev iation.|


Economic growth in Chile, Mexico and the rest of Latin

America

While Chile exhibited relatively high growth rates from the mid-eighties

on, during this period Mexico grew at only slightly higher rates as other

Latin American countries.

PPP adjusted per capita GDP

Source: Penn World Tables 6.1. IMF’s IFS from 2000 onwards


Index

I. FACTORS BEHIND LATIN AMERICA’S

GROWTH PERFORMANCE

II. MEXICO AND CHILE’S COMPARATIVE

PERFORMANCE

III. THE CASE OF MEXICO

IV.FINAL REMARKS


The Case of Mexico

Mexico has achieved important progress in terms of macroeconomic

stability and in making its financial markets more efficient, flexible and

deeper.

On the macroeconomic front we can emphasize among others:

the switch from a rigid to a flexible exchange rate regime;

an improved discipline in the conduct of fiscal policy;

a pro-active public debt management. In particular, the government has

achieved important increases in the average maturity of its domestic debt

instruments with a fixed interest rate;

a monetary policy based on the inflation targeting framework. This has

contributed to the attainment of the lowest inflation figures in more than

thirty years; and,

an important diversification of exports, with a large contribution to growth.


The Case of Mexico

On the other hand, structural reforms to the regulation and the

operation of the financial sector have included:

A complete liberalization of the capital account;

a free determination of exchange rate and interest rates; and,

the reform to the social security system.

Additional actions undertaken to improve the functionality of the

financial market include:

The promotion of efficient exchange and capital markets;

the provision of an adequate legal and regulatory structure;

transparency, information and protection to the investor; and,

modernization of the debt market’s infrastructure and operating procedures.

These actions have allowed to complete markets and, through this

venue, to achieve a better allocation of risk across economic agents.


The Case of Mexico

As a consequence of macroeconomic stability and of the reforms in the

financial sector, economic agents may now access financial markets

under better conditions, in terms of maturity and cost, and more

economic agents have access to credit. That is, liquidity constraints

are being gradually reduced.

These events have allowed private consumption to exhibit a smoother

pattern and, thus, to reduce volatility of GDP. As a result, for the first

time in decades Mexico has exhibited a run-of-the-mill business cycle.

Finally, it is important to emphasize that these developments have

important effects on enhancing welfare.


The Case of Mexico

However, Mexico’s still relatively low expected growth prospects

probably reflect a gradual loss of international competitiveness.

This emphasizes the need to follow through with additional structural

reforms. Among other issues, Mexico requires:

a fiscal reform that enhances revenues and allows resources to be directed

to basic social needs, infrastructure and education;

enhance the energy sector’s infrastructure, productivity and efficiency,

through a larger involvement of the private sector;

improve incentives in the labor market to induce flexibility and promote

technological change; and,

finally, reforms that strengthen the institutional framework and, in

particular, that enhance the rule of law.


Index

I. FACTORS BEHIND LATIN AMERICA’S

GROWTH PERFORMANCE

II. MEXICO AND CHILE’S COMPARATIVE

PERFORMANCE

III. THE CASE OF MEXICO

IV.FINAL REMARKS


Final Remarks

Latin America has lagged behind other regions with much higher

growth performance. This reflects both immediate factors, as lower

savings and investment rates, as well as more profound factors, such

as the lower investments in infrastructure and human capital,

macroeconomic instability and, especially, inappropriate institutions.

In order to revert this situation, Latin America needs profound

structural reforms. The first generation reforms were undertaken

incompletely and inefficiently, and are clearly not enough for Latin

America to restore higher rates of growth.

In particular, more effort is needed to enhance competition in the

markets and to consolidate the reforms already undertaken by

introducing second generation reforms that improve the institutional

framework that governs economic activities.


Final Remarks

A clear example of the potential benefits that can be reaped if the

reform agenda is continued is provided by Chile. This country achieved

especially high growth rates since the eighties, to a large extent, as a

consequence of the deep reforms it undertook.

Mexico, on the other hand, conducted similar reforms, but more than a

decade afterwards. This time lag may be a factor explaining the lower

growth rates that Mexico has achieved, as compared to Chile.

However, some indicators suggest that Mexico’s past reform efforts

were also insufficient, as compared to those of Chile. Mexico’s past

reforms need to be strengthened with a new set of structural changes

in order to improve its growth performance. In other case, Mexico may

easily keep losing competitiveness in the world markets and, as a

consequence, may not reap the benefits of past reforms.

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