Economics of Latin America & the Caribbean. LISTING OF LATIN AMERICAN COUNTRIES Argentina Belize...

Economics of Latin America & the Caribbean

LISTING OF LATIN AMERICAN COUNTRIES

Argentina Belize Bolivia Brazil Chile Colombia Costa Rica CubaDominican Republic Ecuador El Salvador Guatemala Honduras MexicoNicaragua PanamaParaguay PeruSuriname UruguayVenezuela (other) French Guiana… a colony

LISTING OF CARIBBEAN ISLAND NATIONS

Anguilla - Antigua and Barbuda - Aruba - Bahamas - Barbados - Bermuda - Cayman Islands - Cuba - Dominica - Dominican Republic - Grenada - Guadeloupe (French) - Guyana - Haiti - Jamaica - Martinique (French) - Montserrat - Netherlands Antilles - Puerto Rico - Saint Kitts & Nevis - Saint Lucia - Saint Vincent & Grenadines - Trinidad and Tobago - Turks and Caicos Islands - Virgin Islands

GDP

valuation GDP per Income Poverty HumanEnvironmen

t Quality Annual

based on PPP capita equality Index Development Performance of life economic

Country 2008 Current (PPP) (2001-06) 2005 2008 2008 2005 growth (%)

Billions USD 2008 USD Gini index HPI-1 % HDI EPI index 2007

Argentina $570.53 $14,354.00 51.3 4.1 0.860 (H) 81.8 6.469 8.7

Bolivia $43.45 $4,332.00 60.1 13.6 0.723 (M) 64.7 5.492 4.6

Brazil $1,975.90 $10,298.00 57 9.7 0.807 (H) 82.7 6.47 5.4

Chile $246.48 $14,688.00 54.9 3.7 0.874 (H) 83.4 6.789 5.1

Colombia $402.46 $8,336.00 58.6 7.9 0.787 (M) 88.3 6.176 7.7

Costa Rica $48.92 $10,832.00 49.8 4.4 0.847 (H) 90.5 6.624 7.3

Cuba N/A N/A N/A 4.7 0.855 (H) 80.7 N/A N/A

Dominican Republic $76.19 $8,558.00 51.6 10.5 0.768 (M) 83 5.63 8.5

Ecuador $104.67 $7,518.00 53.6 8.7 0.807 (H) 84.4 6.272 2.5

El Salvador $43.89 $6,052.00 52.4 15.1 0.747 (M) 77.2 6.164 4.7

Guatemala $66.84 $4,899.00 55.1 22.5 0.696 (M) 76.7 5.321 5.7

Haiti $11.68 $1,292.00 59.2 59.2 0.521 (M) 60.7 4.09 3.2

Honduras $32.67 $4,085.00 53.8 16.5 0.714 (M) 75.4 5.25 6.3

Mexico $1,550.26 $14,581.00 46.1 6.8 0.842 (H) 79.8 6.766 3.2

Nicaragua $16.75 $2,704.00 43.1 17.9 0.710 (M) 73.4 5.663 3.8

Panama $38.31 $11,255.00 56.1 8 0.832 (H) 83.1 6.361 11.5

Paraguay $29.34 $4,767.00 58.4 8.8 0.752 (M) 77.7 5.756 6.8

Peru $244.69 $8,584.00 52 11.6 0.788 (M) 78.1 6.216 8.9

Uruguay $40.66 $12,707.00 44.9 3.5 0.859 (H) 82.3 6.368 7.4

Venezuela $362.77 $12,933.00 48.2 8.8 0.826 (H) 80 6.089 8.4

Notes: (H) High human development; (M) Medium human development

Latin America Update (2010)

• In the five years between 2004-2008 Latin America’s economies grew at an annual average rate of over 5%.

• Inflation remained generally low.

• Credit expanded and exports boomed.

• Proportion of people living in poverty fell from 44% in 2002 to 33% in 2008.• Until the fall of 2008 Latin Americans could still hope that they would escape the worst of the downturn.

• But in the last three months of ‘08, Latin America saw its stock markets crash, currencies wobble and credit start to dry up. That came on top of falling exports and the plunge in the prices of the commodities it sells to the world.

• Estimate: regional GDP declined 3.6% in 2009.

• Remittances (money being sent home by Latin Americans working abroad) has fallen sharply.

• Still, the region withstood the global economic decline better than had been anticipated in 2009, and is rebounding quickly.

• The regional economic powerhouse, Brazil, continued to see strong inflows of foreign direct investment even while its economic output contracted 1.2%.

• The increase in commodity prices after March of 2009 helped most Latin American countries.

• As a whole, the OECD expects Latin American and the Caribbean to recover modestly in 2010 and 2011, with growth of 2.2% and 3.2% respectively.

• Growth in the English speaking Caribbean will be very weak to begin with, with growth returning to most of these economies only late 2010/early 2011 (tourism).

• Much will depend on what happens with the Global Economy in general and the US in particular, in the second half of 2010.

.

• Many fear that Latin America will revert to it’s dictatorial and populist past that was often characterized by the seizing of foreign assets along with fiscal and monetary irresponsibility.

• This may be a concern for Venezuela, Bolivia and Ecuador, but throughout the region democracy has quickly formed deep roots.

• Results from a October 2009 Latinobarómetro poll (left) indicates that the countries of Latin America may not only be diverging economically in the coming years, but we may witness political divergence as well.

• Most Latin Americans see themselves as politically moderate, but they retain a yearning for strong leaders and expect the state to solve their problems.

• Latin Americans generally support democracy and its institutions, although many remain frustrated by the way their political systems work in practice (weak rule of law, widespread corruption and cronyism).

General risks…

• Biggest risk in the region is of abandoning the recent commitment to fiscal and monetary prudence.

• While most of the poorest are nowadays covered by government cash-transfer programs, those in the third to the fifth deciles of income distribution are now at risk of falling back into, or going deeper into, poverty.

• Corruption is still a major obstacle…and may worsen in the short run.

Update on the Caribbean…

• On October 15th, 2008 in Barbados, 13 Caribbean countries approved a new Economic Partnership Agreement (EPA) with the European Union.

• The EPA involves only gradual changes to a trading relationship which goes back to colonial days. It grants almost all Caribbean exports duty-free and quota-free access to Europe. In return, the Caribbean will phase out duties on 87% of European imports by 2033.

• Until late 2008 these countries have had one-way access to European market (since 1975 under the Lomé Convention, and its successor, the Cotonou agreement)

• Pattern of trade relations between Europe and the Caribbean was no longer in synch with the rules of the WTO.

• The agreement will help the Caribbean to develop new exports, and to rely less on old staples like bananas and sugar.

• US is still the largest trading partner with, and investor in, the region.

• Still, the most dynamic business opportunities in the coming decade will be between countries in the region and the EU.

• The big story for 2010 may be Cuba.

Trade between US and Caribbean Countries

Millions of US $ (2007)

USExports

Nation’s Imports

Antigua and Barbuda

$240 $9

Bahamas $2,473 $523

Barbados $457 $40

Belize $234 $113

Dominica $84 $2

Grenada $83 $9

Guyana $188 $147

Jamaica $2,318 $789

St. Kitts and Nevis $203 $61

St. Lucia $166 $36

St. Vincent and Grenadines

$69 $1

Suriname $306 $136

Trinidad and Tobago $1,779 $9,342

Dominican Republic $6,091 $4,328

Haiti $711 $500

Cuba $447 $0

Aruba $529 $3,070

Bermuda $660 $24

Netherlands Antilles $2,082 $810

Each year, Transparency International draws on surveys of businessmen and country experts to gauge perceptions of corruption in 180 countries around the world. It defines corruption as the abuse of public office for private gain. This year, Chad shared the bottom slot with Bangladesh. Corruption has declined significantly over the past year in a number of countries, including France, Hong Kong, Taiwan and Nigeria.

Transparency International

CORRUPTION PERCEPTIONS INDEX: 2008

country country 2008 CPI

rank score

109 Argentina 2.9

102 Bolivia 3

80 Brazil 3.5

23 Chile 6.9

70 Colombia 3.8

47 Costa Rica 5.1

65 Cuba 4.3

102 Dominican Republic 3

151 Ecuador 2

67 El Salvador 3.9

96 Guatemala 3.1

177 Haiti 1.4

126 Honduras 2.6

72 Mexico 3.6

134 Nicaragua 2.5

85 Panama 3.4

138 Paraguay 2.4

72 Peru 3.6

23 Uruguay 6.9

158 Venezuela 1.9

The Puzzle of Latin America Economic Development: Diversity, Trends and Conflict

• The nations of Latin American and the Caribbean are engaged in programs of political and economic liberalization that may prove as historic as their struggles for independence from Spain and Portugal.

• After decades of political instability, corruption, and military dictatorship, many countries in the region seem to be developing stable democracies.

• Markets long protected from competition are opening to foreign trade, foreign investment, and regional cooperation.

Issue #1: The Economic Landscape

• Diversity: The nations of Latin America are different from each other in many ways. Many of them also have a large amount of diversity within themselves.

• Regional trends: Changing from a rural to an urban society, an increase in population, and new found deposits of natural resources. The countries have instituted different types of political structures and domestic policies.

• The five major issues that confront Latin American countries today:

1. External Balance

2. Credibility

3. Distribution

4. Sustainability

5. Role of the State

• The net effect of the reforms initiated in the 1980s and 1990s may very well result in a divergence among the nations of Latin America over the next 25 years.

• Those that successfully address these five issues will see their people’s fortunes rise, while those that fail will experience sub-par economic growth and political instability.

• The importance of running a consistent balance of payments surplus => boost reserve of domestic financial capital. Role of national savings rate.

• What is the difference between economic growth and development?

• Author’s definition of development: “… a process of meeting the basic human needs of the population and enhancing options for the allocation of economic resources both today and in the future to increase the choices citizens have in their daily lives.”

• UN Millennium Development Goals…pgs. 14-15

• Role of technological change: the world technology frontier.

Human Development Index

• “Dualism” => the rich become richer and the poor more destitute in the process of change (without access to resources, the poor often become poorer)

… the simultaneous existence of modern and traditional economics.

… complicates the policymaker’s task (must address the “social deficit”).

• Todaro: “… growth must be accompanied by a change in the economic and social rules of the game.”

• Therefore, economic growth is a necessary, yet not sufficient, condition for economic development.

The Human Development Index (HDI) is an index combining normalized measures of life expectancy, literacy, educational attainment, and GDP per capita for countries worldwide (ranges from 0 to 1 with green being greater than .85, yellow between .85 and .5 and red below .5)

• Growth of output must outstrip population growth to improve the resources available to people.

Tasks of policymakers in designing development policy:

1. They must establish a delicate balance between the external sectors and domestic macro policy.

2. They must be attentive to the changing nature of the global economic environment as well as preserve confidence and stability within their own economies.

3. To attain equitable growth, they must fashion policies to target different economic, ethnic, and gender groups.

4. Their policies must balance the allocation of resources between meeting the needs of the present as well as future generations (i.e. sustainable development).

5. Must face the challenge of deciding the extent to which each state should supplement the activities of its own markets to facilitate equitable, sustainable development.

Three basic schools of thought: Development Theory

1. Planning Model…

a. Dependency theory: Center vs. Periphery

2. Institutionalist Model…

a. Structuralists…asymmetric development (bottlenecks)…an economy also shaped by power and politics.

b. Heterodox theory…a flexible approach

3. Orthodox Model…

a. Chicago School…grounded neoclassical economics

b. Washington Consensus

c. IMF

Issue #2: Historical Legacies…Patterns of Unequal

& Unsustainable Growth

• What were the Spaniards main goal in coming to the New World?

• What kind of social and political system did they set up?

• Difference between peninsulares and creoles?

• Imperial trade restrictions.

• What is the meaning of the terms mercantilism, monoculture and “Dutch Disease”?

• Agricultural development: workers labored on a debt peonage structure => the latifundios (production for the world market … the best land … the encomieda system <repartida: quinto>) and minifundios (subsistence farming … marginal land). Model of self-sufficiency (feudal concept of manor).

• Why was Brazil overlooked by the Spanish?

• Independence and entry into the world economy: Most nations gained independence in the early 1800s. Followed by a period of turmoil: territorial disputes. In the 1840s, Latin America began to enter the world trade market, especially with Great Britain.

• What was “The Golden Age (1870-1914)”?

• The Golden Age occurred in Latin America between 1870-1914 and was so called because of the increased demand for exports, the tremendous growth in population and new transportation technology.

• Stalled Progress (1914-1930): During this period, the U.S. replaced Great Britain as the primary trading partner and investor of Latin America. Export led growth slowed during this period because of falling prices and because of World War I: ”scissors” effect + Engle’s Law.

• The 1930s (the Great Depression): The main causes of problems in Latin America were capital flight, contracting income because of declining export prices, insular multinationals, lack of forward and backward linkages from prior development.

• The 1930s was a political watershed period in Latin America with its "increased social pressure, numerous strikes, the emergence of radical parties, and nationalist rhetoric." A new development model emerges.

Issue #3: Theories, Ideas, and Opinions

Divergent Opinions: The major economic problems plaguing Latin America are low incomes, unequal income distribution, periods of hyperinflation, negative balance of payments and periodic debt crises.

• Many of the proposed policies are radical because the problems are so extreme that it appears minor changes in policy will not work.

Why is Latin America underdeveloped?

1. Dependency theory … periphery? … center?

• Harsh critics of foreign direct investment and MNCs .

2. Mainstream interpretations …

• Resource endowment…global geography.

• The conventional, mainstream economists say that underdevelopment is caused by small market size, slow capital accumulation (low domestic savings), shortages of foreign exchange, unskilled labor, and poor political organization (inefficient public institutions).

• Late out of the gate: no agricultural revolution, lack of an investment climate, needed transportation revolution, imperial opposition, opposition from within… difficult to catch up from behind.

• Three positive effects from foreign direct investments and MNCs?

1. Foreign firms bring superior technology.

2. Increases competition in the host economy.

3. Foreign market access.

Concepts to Define & Understand at the Beginning…

1. Comparative advantage - def: A nation has a comparative advantage over a trading partner in the production of an item if it can produce that item at a lower unit cost than its partner.

Implications...a. Any country can increase its income by trading, because the

world market provides an opportunity to buy some goods at relative prices that are lower than those which would prevail at home in the absence of trade.

b. The smaller the country the greater this potential gain from trade, but all countries benefit to some extent.

c. A country will gain most by exporting commodities that it produces using its abundant factors of production most intensively, while importing those goods whose production would require more of the scarcer factors of production.

2. Balance of Payments - Exports (X) & Imports (M)

B of P = PxX – PmM

Px = vector of prices of exports

Pm = vector of prices of imports

Surplus = excess of exports over importsDeficit = excess of imports over exports

• Merchandise trade account, capital account, reserve account• Engle’s Law again => deteriorating terms of trade over time.

3. Exchange rates - def: The price of one nation's monetary unit in terms of the monetary unit of another country.

- Foreign exchange market: A market in which buyers and sellers of bank deposits denominated in the monetary unit of many nations exchange their funds.

- Exchange rates can be allowed to fluctuate freely, can be "managed" or can be pegged to the currency of a major trading partner.

=> Graph (500p:1$ or 1p:.002$)

Demand side - People who want to import Chilean goods, or travel in Chile, or others who just want to hold pesos.… When North Americans demand more Chilean vegetables, copper, wine, or whatever, (D curve shifts right) the price of the peso will rise in terms of dollars.

Supply side - those who want to import goods into Chile from the United States or hold $.

(1) When Chileans demand more US cars or computers (S curve shifts right) the price (in $) of the Chilean peso will tend to decline (S of peso shifts r).

Appreciation and depreciation of a currency: When country A's currency becomes more valuable relative to country B's, country A's currency is said to appreciate relative to that of country B … and country B's currency is said to depreciate relative to that of country A.

Determinants of Exchange Rates:

1. What determines the relative positions of S&D curves for currency?

(a) Relative price levels - constantly changing (inflation)

(b) Relative rates of growth

(c) Relative interest - rate levels

(d) Expectations/Speculation…

Example of Argentina…

(e) Random daily trade and financial flows…noise (3.8 trillion per day)

Note: Market exchange rates vs. PPP rates (purchasing power parity).

4. Domestic Absorption (A) = The national expenditures on both home-produced goods and imports.

- Not equal to B of P...If A>GDP => trade deficitIf A<GDP => trade surplus

- How does a nation pay for domestic consumption (absorption) above and beyond GDP? => Draw down domestic savings, sell domestic assets and/or borrow from abroad (increase external debt).

5. Import Substitution Industrialization development strategy: - The substitution of domestic production for imports of foreign manufactures.

-Was first explored by Latin American countries when their primary exports markets were severely disrupted, first by the Great Depression of the 1930s and subsequently by the breakdown of commercial shipping during World War II.

-What are forward and backward linkages?

Econ. 4132Econ. 4132

The Big Mac Index (7/2009)

The Big Mac index is based on the theory of “purchasing-power parity”. Under PPP, exchange rates should adjust to equalize the price of a common basket of goods and services across countries. Our basket is the Big Mac.

Video Clip

- Emerging from the war with fledgling industries, countries like Argentina, Brazil, Columbia, and Mexico began systematically to sustain these manufactures by erecting tariffs and other barriers to trade-competing imports from the US.

-Latin America developed import substitution regimes with a multitude of protective techniques that were later emulated by other developing countries.

Conditions for success:

(1) Identify large domestic markets, as indicated by substantial imports over the years.

(2) Ensure that the technologies of production can be mastered by local manufacturers or that foreign investors are willing to supply technology, management, and capital (joint ventures).

(3) Erect protective barriers - Either tariffs or quotas on imports, to overcome the probably high initial cost of local production and make it profitable for potential investors in the target industries (“infant” industry argument).

First targets => Consumer goods industries (processed foods, beverages, textiles, clothing, and footwear)… have

technologies easily obtained and mastered by domestic producers.

(4) Keep an overvalued exchange rate => Imports are cheap (intermediate inputs are cheap) and exports are expensive to foreigners (reduced dependence of foreign markets for economic well-being: Foreigners just won't buy your products).

(5) SOEs… and why? Key industries vs. natural resources (p. 62).

(6) Role of MNCs? Subject to restrictions (p. 67).

Marked change in national economic policy began in the 1950s:

• Following the end of the WWII, most Latin American governments formulated clear policies to foster "import-substituting industrialization".

- Governments improved the region's transport system and expanded the infrastructure for electricity and water.

- Governments helped finance local industry and welcomed foreign corporations willing to establish factories in certain industries.

- Still the strategy failed to resolve the Latin American tendency to import more than it could export.

- In fact the import strategy contributed to the problem because the new factories were dependent on foreign suppliers for machines, spare parts and intermediate products.

- As the policy ran its course, domestic markets became exhausted... if economic growth was to be sustained at home, then foreign debts had to be incurred (keep political promises). (4) Eventually, many developing nations faced a breakdown… (run out of loans and must reduce exchange rates).

- When this occurred the wealthy and powerful were the first to know: domestic currency will exchange into a larger number of foreign currency per unit. Economic reality => the national currency must depreciate => Capital flight: Causes the domestic currency to depreciate rapidly. In other words: this strategy ended with a crisis.

- Devaluation typically reduces imports and increases exports but in the import trade strategy environment, the dependency on imported goods made the demand for foreign goods inelastic => imports did not fall yet became more expensive to obtain.

- Also, reducing imports would mean reduced employment (populist politicians would not accept) => net result: worsening of the balance of payments/foreign exchange problems.

[a] Government felt compelled to borrow as much as possible from external sources (plus to print money to pay their domestic bills).

(5) In addition, levels of efficiency in the new industrial plants were sometimes rather low: due to limited size of the home market.

… Many producers used technology designed to produce high volumes of output (higher than Latin American countries could support)

… Many firms operated at capacity levels below 50%!

(6) Under the ISI regimes governments introduced productive tariffs and quotas (or total ban on certain imports) to protect domestic producers and in some instances domestic producers had monopoly status => little incentive to improve management or labor practices so the prices of local manufactures rose well above international prices.

[a] Also, very powerful domestic interests resisted dismantling tariffs and quotas that protected their favored status.

(7) Next, the rate of job creation was much lower than had been hoped for… - largely because of the rapid growth of the labor force (from both urban migration and high rates of population increase).

- Also, the problem was made worse because the technology incorporated in domestic industry was often capital-intensive even though more labor-intensive techniques were available.(8) Finally, the import-substitution strategy and associated domestic growth was bound to slow down eventually because of small markets without hope of exports (due to overvalued exchange rate).… but it worked for a while (5.5% growth: 1950 – 1980)

6. Export oriented trade policy & development strategy: (outward looking trade strategy or the “neoliberal agenda”)

- Allows a nation to realize, as fully as possible, the inherent gains from their comparative advantage through free markets.

- Often means primary-export-led growth (drawbacks: volatile price swings…and limited revenue upside due to Engel’s Law).

- Starting in the 1960s there were the beginnings of an intellectual return to free trade thinking and attempts were made to encourage Latin American countries to export more to the developed countries.

- Stimulus here was the budding success of the Asian Tigers or NICs (Newly Industrialized Countries: Hong Kong, Korea, Singapore and Taiwan) who were successfully penetrating MDNs’ (More Developed Nations’) markets.- Encouraged by the advice of the World Bank, several governments including those of Brazil and Colombia began to reduce levels of domestic protection and to give incentives to export producers.[a] By 1970 this had become an accepted way of sustaining industrial expansion.

Conditions for Success: (1) Maintain an exchange rate that helps make it profitable for domestic producers to sell their crops, manufactures, and services on world markets. The lower the exchange rates, the more desirable the nation’s products will be to foreigners.

* As exchange rate decreases => exports rise while imports fall => goal: to get nation to run a balance of payments surplus => give them foreign currency to service and reduce external debt.

(2) It may be necessary to subsidize some exports to induce manufacturers and farmers to invest in capacity for the export market (infant industry argument again).

(3) If governments want producers to turn towards world

markets, they must reduce the relative attractiveness of production for the domestic markets => reduce high protective tariffs for favored industries, eliminate quotas on imports and reduce regulations.

7.Hyperinflation - Inflation (absolute increase in price level) at very high rates of usually 200 percent or more prevailing for at least one year (table on page 108).

… Caused by one factor…government printing too much money to pay its bills (Seniorage…or, quantitative easing).

… Why is it bad?A. Uncertainty and therefore higher risk => less investment

(both from domestic and international sources). Induces the outflow of financial capital and reduces FDI. The poor flee to dollars.

B. Functions of money destroyed... store of value, unit of accounting, unit of exchange.

… No lubricant to machinery of economy => friction=> slows down (people revert to barter).

C. Encourages speculation... Diverts effort away from production.

D. But why do it? Effectively a tax without increasing official tax rates: government uses money right after it is printed thereby using it when it has the greatest purchasing power... those who receive it later have reduced purchasing power therefore have transferred, unknowingly, some of the purchasing power which would have been theirs to the government (inflation tax).

… especially impacts the poor.… it is not understood, so most citizens don’t blame

government.E. Solution... New currency or abandon currency ($...El

Salvador and Ecuador have done; plus the US $ accepted almost everywhere).

8. The International Monetary Fund (IMF):What is it?- International role of IMF is to extend emergency credit (Short

Term!) to member nations who get in trouble.- Critics=> IMF tool of MDNs lying in wait to get control of the

nation's economic policies and reshape them in a monetarist, market oriented, conservative model.

- Problem: Has had a standard package that includes:[1] Monetary & Fiscal restraint.

… Monetary restraint reduces domestic demand and reins in inflation (also ties politicians’ hands so they can’t use seniorage). … Government spending reduced (reduce size and involvement of government). Create fiscal prudence by bringing the federal budget in balance. [2] Currency Devaluation… Goal: Reduce excess demand and to reorient the structure of national production away from imports and toward exports (with low import content; a comparative advantage… often focused on labor intensive manufactured goods and primary products).

… also reduces appeal of capital flight. [3] Cut subsidies and other trade impediments (tariffs, quotas, rules & regulations) => open up economy to global market forces. [4] Limit on wage rate increases… in countries with high inflation there are also price controls to help break inflation psychology [structural inflation]… Argentina, Brazil and Peru. [5] Overhaul tax structure to reduce loopholes for wealthy and to make more efficient. Note: There’s been little progress on this one.

- All subject to periodic review: If they haven't followed guidelines they lose additional funding or must accept and even more stringent set of guidelines.

=> funding is received in installments over period of the loan.

• Capital flight: A rapid and massive conversion of domestic currency for that of a major international reserve currency and movement of that reserve currency out of the country to an off-shore financial haven.- When devaluation is about to occur, the wealthy and powerful are the first to know.- The overvalued exchange rate means that just before crisis point the domestic currency will exchange into a larger number of foreign currency per unit. - Economic reality => the national currency must depreciate => capital flight: helps to depreciate the domestic currency rapidly in a short period of time (depletion of reserve account).- This often creates volatile financial markets, increases risk, increases interest rates, social unrest and reduces economic growth.- It is also followed by a period of inflation (… actually stagflation).- Psychology imbedded in wealthy Latin culture to have one financial foot in and one financial foot out of home country (keep a house and bank account in Miami).

Evaluating and Comparing Economies:

A.Need some definitions before we go on...•Institution: Institutions are rules of the society that structure

the interaction among people.- Are made up of formal rules and regulations.- And informal rules as well at times (important in LA!).- They are the informed ways by which people deal with each

other every day → norms of behavior.- Institutions, collectively, are the framework within which all

of human interaction... political, social and economic... takes place.

•Economy: The economy of a society is comprised of institutions that perform economic functions. These institutions are structured and behave according to established working rules.

•Philosophical Basis for an Economy: A viewpoint which specifies the place of an individual within society; an ideal state of political, social and economic reality to serve as a set of ultimate goals for society; and a general program suggesting broad policy measures that will guide society from its actual conditions toward the ideal reality. This economic philosophy will be multidimensional in the sense that social, political, and cultural, as well as economic elements are contained therein.

1. Capitalism → Adam Smith - dominance of "the invisible hand" in guiding economic activity. Limited role of government (provide public goods and define the rules of the game). A “process” ideology.

B. Institutional Economics:

1. While there is no hierarchy of importance in the tenets of institutional economics, one of the most important for our purposes is that...

[a] Economies are fluid rather than static.[b] The second tenet is that one can understand an economy only within its historical context.

- The constellation of factors shaping an economy is unique.

- A corollary to this tenet is that what might work for one nation might not work for some other due to historical

inconsistencies.[c] Third, the values of a nation's people can be understood best by studying the philosophical/religious underpinnings of its culture.

- Old and new philosophies alter attitudes that may subsequently lead to a change in work rules and therefore institutions.

[d] A fourth general tenet is that the values, institutions and work rules which operate in one nation will not necessarily function in another nation. - A corollary tenet is that values, institutions and work rules which functioned in the past may not function in the future. G. C. Allen: "One of the most common fallacies in the minds of academics, or the citizenry of a nation, is that once a trend is established it will persist indefinitely."

[e] Finally, the basic structure and performance of an economy are influenced by the dynamics of the society's social and political structure.4. This broad theory is based upon the interrelationship between a society's beliefs, power structures, and working rules of institutions.

[a] The theory can be used to explain the nature and evolution of economic systems.

[b] Changes in working rules can modify institutions or create new ones, with the economy evolving in the process.

[c] The philosophical basis accepted by authorities and the economy's performance determines whether the working

rules are retained, modified, or replaced.

5. Working rules...

- Establish the boundaries of economic activity between institutions.

6. Principal institutions...

- Socially determined: not inherent.

[a] Instrumental in establishing and coordinating most production and distribution patterns of behavior, and giving meaning and durability to routine activities.

[b] Significant features: Origin, the activities participants perform, working rules governing them, their impact on the economy, and the philosophical basis for these activities and rules.

7. Behavior of the economy...

- Three components: How it is organized to resolve the economic problem(s) (what, when, how, for whom), institutional change, and performance.

• In describing how each society is organized to resolve its economic problem, three questions need to be addressed:

1. How is the resource allocation decision organized...

[a] Centralized (state control) or decentralized (markets) or some combination. Decision making rules and institutions.

2. What are the rules regarding ownership and control over productive resources?

- In each economy the rules differ...even where similar, differing restrictions exist.

3. What type of social process has been adopted for coordinating information and for making production and distribution decisions?

- Including markets, traditional mechanism, or some form of economic planning.

II. Evaluating and Comparing Economies:

- The performance of an economy is influenced by goals and priorities established by authorities and by environmental factors such as technology, natural resource endowment, and international economic and political factors... all interrelate.

- How the economy performs, relative to stated goals and priorities (prevailing norm), determine which other economic, social or political policies are necessary.- Evaluating and comparing economies cannot be purely objective.

… Conclusions influenced by the analyst’s point of view... the comparor’s norm.

A. Evaluating the performance of an economy...

1. An economy's performance can be defined in many ways, depending upon the performance criteria, methods of measurement and weights attached to each criterion when overall performance is calculated (the performance index).

- The choice of criteria is up to the analyst (you!).

2. Four steps to follow:

a. The analyst’s definition of performance.

b. The identification of performance criteria.

c. The choice of performance indicators for each criterion.

d. The compilation of a performance index for cross-comparisons. … Includes weighting - must be made explicit (you will not be expected to do this)

e. Need for a “benchmark” country.

3. Criterion examples:

- Economic growth (change in GDP or GDP per capita)

- Economic stability (low inflation, stable exchange rate, low unemployment, lack of deficits, etc.)

- International balance of trade, external debt, and currency values

-Income distribution... Lorenz Curve (Gini Coefficient) -World Atlas of Income Inequality

- Quality of life: e.g. Human Development Index (United Nations)

… other indices: Corruption, Competitiveness, Economic Freedom

Approach in writing a course paper on a country (ideal)…

Mexico 1. Introduction.: Start with overview of country/issue plus some current statistics.

• Population: 108.7 m (2007)

• Population growth: 1.2% (average, 2003-2007)

• Land area: 1.9m sq km (about three times the size of Texas)

• Currency… Mexican peso (Ps): 12.95 pesos to the dollar (Feb. 2010)

• GDP: US$ bn; market exchange rate: $893.4

US$ bn; purchasing power parity: $1,345.8

• GDP growth: 3.3 % (average, 2003-2007)

• GDP per head

GDP per head (US$; market exchange rate) $8,219

GDP per head (US$; purchasing power parity) $12,381

• Inflation: 4.2 % (average, 2003-2007)

• Background:

Mexico was ruled by the Partido Revolucionario Institucional (PRI) and its predecessor, the Partido Revolucionario Nacional (PRN), between 1929 and 2000. Once strongly nationalist and interventionist, the leaders of PRI governments in the 1990s embraced free-market policies and economic liberalization. Following the victory in July 2000 of Vicente Fox Quesada, the presidential candidate of the centre-right party, the Partido Acción Nacional (PAN), changes to the political system are slowly taking place. The PRI remained the largest party in Congress during the Fox years, but it became less enthusiastic about free-market policies. Current president: Felipe Calderon (PAN).

• Political structure:

The political system is presidential, bicameral (Senate and Chamber of Deputies) and federal (32 states). The president is elected every six years; Mr. Calderon took office in December 2006. The 500 members of the Chamber of Deputies are elected every three years, 300 from single-member districts and 200 by proportional representation. Three-quarters of Senate members are elected directly for a six-year term with the remaining one-quarter elected by proportional representation.

Key indicators & Forecasts

2007 2008 2009 2010 2011 2012

Real GDP growth (%) 3.3 2.3 1.6 3.4 3.8 3.6

Consumer price inflation (%)

4 5.2 5.2 3.6 3.4 3.3

Commercial banks' prime rate (av; %)

7.6 8.3 8.5 7.1 7.4 7.4

Current-account balance (% of GDP)

-0.6 -1.1 -1.2 -1.5 -1.6 -1.4

Major exports 2007

% of total

Major imports 2007

% of total

Manufactures 80.7 Intermediate goods

72.9

Maquiladora 44.7 Maquiladora 34.2

Oil 15.8 Consumer goods

14.8

Agricultural products

2.8 Capital goods 12.3

Leading markets 2007

% of total

Leading suppliers 2007

% of total

US 82.1 US 49.6

Canada 2.4 South Korea 10.5

Spain 1.5 China 5.8

Germany 1.3 Japan 4.

2. History … be brief.

- philosophical basis (prevailing norm)

- identify principal institutions in the social, political and economic spheres

- discuss notable working rules of these institutions

3. Methodology (more on this below): Explicitly state your comparor’s norm … contrast with prevailing norm. Define your performance criteria, consistent with your comparor’s norm, and provide the data on your chosen country/issue and your benchmark country.

4. Behavior/Analysis of economy (recent).

5. Evaluation from point of view of your performance criteria…benchmark country for comparison.

6. Conclusion…

- what can you now say about this country/issue?

- do some forecasting: where are things going from here?

7. Footnote/Endnotes

• I have already chosen Mexico as my primary country…

• My benchmark country will be Argentina.

• Comparor’s norm: I think the standard of living is important and strongly correlated with good social indicators (healthy diet, access to health care, good sanitation, access to education, etc.). Since inflation has been a problem in the past…and can devastate purchasing power…that stable, relatively low inflation is a must to maintain a productive economic environment. Finally, to compete in the global economy I think access to technology is crucial for the people.

• Performance criteria: The amount of income per person in real dollar/peso terms will measure standard of living. The change in national prices each year will measure inflation. Finally, the availability and spread of advance technology will lead to the ability to compete in the global marketplace.

• Performance indicators:

1. Inflation, GDP deflator (annual %)

2. GNI per capita, PPP (current international $)

3. Fixed line and mobile phone subscribers (per 1,000 people)

Mexican Inflation in Comparison to Argentina's

Year Mexico (Inflation:

GDP deflator)

Mexico (Percent change

from previous

year)

Argentina (Inflation:

GDP deflator)

Argentina (Percent change

from previous

year)

1995 37.87 --- 3.17 ---

1996 30.74 -18.83% -0.05 -101.66%

1997 17.69 -42.47% -0.46 784.99%

1998 15.39 -13.02% -1.71 267.53%

1999 15.09 -1.91% -1.84 7.70%

2000 12.10 -19.80% 1.04 -156.48%

2001 5.88 -51.43% -1.10 -205.64%

2002 6.96 18.34% 30.56 -2888.45%

2003 8.49 21.98% 10.50 -65.65%

2004 6.10 -28.09% 9.19 -12.48%

2005 8.80 44.22% 5.50 -40.13%

2006 13.50 53.41% 4.40 -20.00%

2007 14.10 4.44% 3.20 -27.27%

Mexican Inflation in Comparison to Argentina's

Comparison to Argentina's

Year Mexico (per capita GNI)

Mexico (Percent change

from previous

year)

Argentina (per capita

GNI)


from previous

year)

1995 $6,690.81 --- $10,178.24 ---

1996 $7,058.22 5.49% $10,811.49 6.22%

1997 $7,551.75 6.99% $11,742.87 8.61%

1998 $7,898.89 4.60% $12,189.31 3.80%

1999 $8,208.48 3.92% $11,815.08 -3.07%

2000 $8,815.06 7.39% $11,850.38 0.30%

2001 $8,885.24 0.80% $11,482.92 -3.10%

2002 $8,976.73 1.03% $10,299.60 -10.31%

2003 $9,136.73 1.78% $11,306.55 9.78%

2004 $9,644.73 5.56% $12,525.94 10.78%

2005 $10,420.00 8.04% $11,180.00 -10.75%

2006 $11,670.00 12.00% $11,970.00 7.07%

2007 $12,990.00 11.31% $12,580.00 5.10%

Mexican Gross National Income per capita (in current international dollars: PPP)

...in Comparison to Argentina's

Year Mexico (Fixed line and mobile)

Mexico (Percent change from

previous year)

Argentina (Fixed line and moblile)


from previous year)

1995 104 --- 171 ---

1996 106 2.18% 193 12.55%

1997 117 10.03% 236 22.75%

1998 139 19.07% 273 15.41%

1999 193 38.60% 323 18.35%

2000 270 39.54% 390 20.68%

2001 358 32.63% 399 2.36%

2002 406 13.47% 379 -4.96%

2003 454 11.87% 433 14.12%

2004 545 19.98% 579 33.75%

2005 820 50.58% 650 12.29%

2006 1050 28.05% 740 13.85%

2007 1260 20.00% 840 13.51%

Mexican fixed line and mobile phone subscribers (per 1000 people)

Mexico (United Mexican States)

• Capital: Mexico City … 8.5 million people.

• Ethnic makeup: 60% mestizo, 30% amarindian, 9% white, 1% others.

• Much of Mexico's territory is vulnerable to earthquakes and volcanic activity. In 1943, for example, a cornfield in one of Mexico's richest agricultural zones sprouted a volcano instead of maize. In 1982, a severe volcanic eruption in the south took several hundred lives, destroyed thousands of head of livestock, and buried crops under tons of ash. Thousands of people died when a series of earthquakes struck Mexico City in 1985.

• Mexico is a nation of climatic extremes. Much-needed rains often fall so hard that most of the water runs off before it can be absorbed by the soil. When rains fail to materialize, crops die in the fields. The harsh face of the land, the unavailability of water, and erosion limit the agricultural potential of Mexico. Only 10 to 15 percent of Mexico's land can be planted with crops.

• Mexico's central region has the best crop-land. It was here that the Aztecs built their capital city, the foundations of which lie beneath the current Mexican capital, Mexico City.

• For decades, Mexico City has acted as a magnet for rural poor who have given up attempts to eke out a living from the soil. - The size and location of Mexico City have spawned awesome problems (the worst smog in the Western Hemisphere, traffic congestion is among the worst in the world, essential public services—including the provision of drinkable water, electricity, and sewers—have failed to keep pace with the

city's growth in population). • Mass communication has had an incalculable impact on culture.

- Television commercials primarily use models who are ethnically European in appearance—preferably white, blue-eyed, and blonde. As if in defiance of the overwhelmingly mestizo character of the population (success has become associated with light skin).

- Television, however, has helped to educate the illiterate: Some Mexican soap operas, for instance, incorporate

educational materials.

Literacy is portrayed as being essential to one's success and well-being.

• Compadrazgo ("co-godparenthood" or "sponsorship") is found at all levels of Mexican society and in both rural and urban areas.

- It is a device for building economic and social alliances that are more enduring than simple friendship. Furthermore, it

has a religious dimension as well as a secular, or everyday, application (informal rules of society).

- The chaos of city life, the hundreds of thousands of migrants uprooted from rural settings, and the sense of isolation and alienation common to city dwellers the world over are in part eased by the Hispanic institution of compadrazgo.

- Compadrazgo performs many functions, including providing assistance from the more powerful to the less powerful and, reciprocally, providing homage from the less powerful to the more powerful (reaches across class lines and knits the various strands of Mexican society together).

• As Mexico City has sprawled ever wider across the landscape, multitudes of new neighborhoods have been created. Many are the result of well-planned land seizures, orchestrated by groups of people attracted by the promise of the city.

- Technically, such land seizures are illegal; and a primary goal of the colonos (inhabitants of these low-income

communities) is legitimization and consequent community participation.

- Beginning in the 1970s, colonos pursued their demands for legitimization through protest movements and demonstrations, some of which revealed a surprising degree of radicalism.

- In response, the Mexican government adopted a two-track policy: It selectively repressed the best-organized and most radical groups of colonos, and it tried to co-opt the

remainder through negotiation. In the early 1980s, the government created "Citizen Representation" bodies, official channels within Mexico City through which colonos could participate.

The Border:

• Driven by poverty, unemployment and lack of opportunity many Mexicans have chosen the United States as the place to improve their lives (2009: estimated at 8.8 million).

• During WWII the presidents of both nations agreed to allow Mexican workers, called braceros, to enter the US as agricultural workers.

• Regardless, each year hundreds of thousands of undocumented Mexicans illegally cross the border in search of work (estimated at 4 to 6 million at any given time).

• For the Mexican government this is a blessing since such mass emigration is a sociopolitical safety valve and results in an inflow of dollars sent home by workers (remittances).

• Still, the US has attempted to stem the flow by negotiating treaties so that US companies and Mexican states along the border would profit from the creation of assembly plants (maquiladoras).

• Low wages and lax labor and environmental law enforcement has resulted in US firms gaining profits while the Mexican government reaps the benefits of employment and tax dollars.

Mexico’s Stability:

• Depends on the ability of the ruling elite to maintain a state of relative equilibrium among the multiplicity of interests and demands within the nation…and to reign in the drug gangs.

• Process characterized by bargaining among elites with various views of politics, social injustice, economic policy, and the conduct of foreign relations.

• The 1910 Revolution (1910-1917) resulted in the Mexican Constitution: A remarkable document in that it covers not only political rights but economic rights as well (e.g. 8-hour work day, minimum wage, 6-week paid leave for pregnant women, etc.)

• Unfortunately, many of the provisions of the 1917 Constitution have yet to be achieved.

• Indian “problem” … they have long endured the unequal practices of a ruling white and mestizo elite.

• Land reform: focus of struggle and occasion for serious human rights abuses.

• Drug gangs…organized, wealthy, powerful and violent.

• Even today, paramilitary bands and local police controlled by political bosses or landowners routinely threaten and/or kill peasant activists. The further south you go in the country, the more acute this problem (Chiapas & Oaxaca).

• Institutional Revolutionary Party (PRI) controlled the federal government from 1929 to 2000; and set policy and controlled all levers of political power.

• Paternalistic and all-powerful, the state controlled the bureaucracies that directed the labor unions (powerful), peasant organizations, student groups, and virtually every other dimension of organized society.

• Even though the PRI lost the presidency in 2000, it remains the most powerful political party.

• The PRI lost power because a series of economic crises alienated the upwardly mobile middle-class.

• In 2000 Vicente Fox headed a coalition of parties that adopted the name Alliance for Change and promised Mexico’s electorate “Revolution of Hope”… he promised to be a “citizen president”.

Economic Crisis:

• In the 1970’s the PRI undertook economic policies designed to foster rapid and sustained economic growth (import substitution).

• Borrowed heavily to fund and achieved economic growth of 8%.

• Backed by its vast deposits of petroleum, the PRI recklessly borrowed to expand its economic infrastructure.

• Petroleum prices plunged in 1981-82… debt crisis. By the end of 1982 40% of Mexico’s export earnings were devoured in interest payments on a debt of $80bil.

• IMF set as a condition for emergency funding a drastic reduction in state spending → layoffs, reduced spending on social welfare programs. Devastated the poor and reduced the standard of living of the middle class.

• In December 1994 the economy collapsed after the government could no longer sustain an overvalued peso.

• The peso fell 50%, while the stock market fell 38%. Ushered in another round of public austerity (Pres. Zedillo) and was the final ingredient in bringing down the PRI.

• US engineered a bailout by backing (attached loan guarantees: “Brady” bonds) a new issuance of Mexican government bonds.

• NAFTA (1992): hope was that it would shore up the Mexican economy and generate jobs. It has for Mexico so that now Mexico is the third largest trading partner of the US. A new trade agreement between Mexico and the EU signed in 2000.

• Resulted in the globalization of Mexico.

• Analysts have noted that NAFTA has contributed to a trend toward more representative government and that globalization has undercut the state-centered regime of the PRI.

• Still, there are far to many Mexicans who live below the poverty level. Of the 40 million poor, 18 million are characterized as living in “extreme poverty” (less than $2 a day).

• Income distribution is skewed with the richest 20% in control of 58% of the nation’s wealth while the poorest 20% control only 4%.

• Questions on Mexico?

Chapter 4: Latin America’s Debt Crisis: The Limits of External Financing “The debt crisis in Latin America was a development crisis.”

The reasons for a debt crisis include …• A chronic deficit in the non-interest current account balance.• A rise of import costs or a decrease in export earnings.• World capital markets lose confidence … capital inflows dry up.

Borrowing is not necessarily bad (investment vs. current consumption).Definition of a Debt Crises: A debt crisis arises when countries fail to meet their

interest and/or principal payments. There are three ways to service national debt:• First, the non-interest current account can be brought into a surplus balance.• Obtain newly borrowed money from international sources in order to cover

old debts.• Other capital inflows such as from foreign direct investment.

Note: Overvalued exchange rates and capital flight contribute to debt crises.→ Over-invoicing of imports and under-invoicing of exports?Causes foreign asset accumulation … but goes into black market.

The 1980s Debt Crisis…

1. Gradual failure of ISI policies during late ’60s and early ‘70s=> need for external money to support.

2. Yom Kipper war => OPEC raises price of oil => stagflation in developed countries => OPEC money floods Eurocurrency market => growth looked relatively good in Latin America because of ISI insulation => money flowed in from Europe => feeding virtuous cycle of growth.

3. US Federal Reserve acted to stop inflation (’80 – ’81) => drained money from US system => caused interest rates to skyrocket => US economy went into a sharp contraction => Latin exports to US tumbled => balance of payments quickly deteriorated and economies stalled.

4. Currency overvaluation and capital flight during 1978-1982 contributed to the debt crisis.

5. Mexico … 1982 (OPEC loses control…oil prices drop). → Brazil, Argentina and Venezuela got into similar trouble shortly thereafter.→ A “sovereign guarantee”→ “external debt to exports” or “debt service to export ratio” (table 4.6)→ Other terminology in box on page 90.

6. Many nations were unable to sustain positive net exports and struggled under the dead weight of ISI => political and economic inertia => The Lost Decade

Debt Crisis Management…

1. What was "the muddling-through strategy“?

• Assumed that debtors would regain their credit-worthiness with a combination of internal adjustment and more favorable world economic conditions.

• Assumes problem is a liquidity not a structural problem.

• Wrong! Led to depressed living conditions, hyperinflation, sharply reduced investment, and reduced long term growth rates.

• What is “conditionality”?

2. Debt-equity swaps.

3. Debt for nature swaps.

4. Buybacks of debt.

5. Debt facilities organized by creditor governments (Paris Club).

6. Relief on interest payments rather than principle.

7. “Provisioning” increased… private financial sector set aside profits before dividend payments against risky loans (protects capital base in case of client default).

8. Development of secondary market for developing country debt (Mexico → $.51 on each dollar of outstanding debt; Peru (1987) → $.02 to $.07 to the $1)

9. The Baker Plan (October, 1985)…

• Plan to jump-start regional growth.

• Premise: countries in region could not repay external debts in the context of contractionary policies (IMF conditionality). Plan was to shift debt crisis policy from austerity to growth.

• Targeted 15 LDCs for $29 billion of new money ($20 from banks and $9 from IMF/World Bank).

• Was a formal recognition that the problems were structural rather than of a liquidity nature → caused policy shift at IMF to tie future loans to growth targets.

• Still, it was too little too late… money spread too thinly to have major impact (almost $1 trillion of debt involved).

9. The Brady Plan … first proposed in 1985 but didn’t get underway until 1989.• Asked banks to forgive part of their loans to debtor countries in exchange for limited guarantees of repayment of remaining outstanding debt.• Three options:

[1] decrease face value of debt (sanctioned buy-back in secondary markets)[2] extend the time period of obligations[3] infusion of new money… swap old loans for new 30-year bonds issued at favorable rates (with guarantees by USA to create incentives for private banks to participate).

• Financed by the IMF and World Bank…backed by the US.• Also asked participating banks to make new loans to debtor countries to help stimulate growth.• Banks not eager to participate. In the end helped Mexico (US forced banks) and Costa Rica (the model country… reduced debt $1.1 billion).

10. Is the debt crisis over in Latin America?• HIPC (highly indebted poor counties, 1995)… goal to reduce the stock of debt of the poorest of the poor (Nicaragua, Bolivia, Guyana, Honduras & Haiti qualify in LA). There are conditions if a nation decides to participate (p. 102).11. Latin America gross external debt and other important metrics (in billions of US dollars) …

Latin America

Economic Indicators, 2002 - 2008

2002 2003 2004 2005 2006 2007 2008

External Sector

Current Account (% of GDP) -0.8 0.5 1.0 1.4 1.5 0.4 -0.7

Trade Balance (% of GDP) 6.5 12.2 13.8 16.0 16.1 9.6 6.0

Current Account (US$ bn) -14.2 9.1 20.6 35.4 45.7 12.9 -26.8

Trade Balance (US$ bn) 21.4 41.3 56.7 77.7 93.6 66.3 49.6

Exports (US$ bn) 348.1 378.5 468.0 563.7 672.8 758.4 879.6

Imports (US$ bn) 326.7 337.2 411.1 485.8 580.1 692.2 830.4

Exports (%-change) 1.2 8.7 23.6 20.5 19.3 12.7 16.0

Imports (%-change) -7.0 3.2 21.9 18.2 19.4 19.3 20.0

Int. Reserves (US$ bn) 160.1 194.2 218.0 249.3 302.4 438.8 500.2

Int. Reserves (ms imports) 5.9 6.9 6.4 6.2 6.3 7.6 7.2

External Debt (US$ bn) 718.8 745.1 745.7 656.2 643.4 712.9 767.9

External Debt (% of GDP) 42.3 40.1 34.8 25.1 21.0 19.8 19.0

The PIIGS in Europe may be headed for their own debt crisis…will it follow a similar pattern?

Chapter 5: Macroeconomic Stabilization: A Critical Ingredient

• What happens in countries with high and accelerating inflation is that people spend more time trying to exchange their money than actually producing … plus speculating and barter. (Bolivia => at one time annualized rate of 60,000 percent).

• In addition, the functions of money are destroyed (unit of accounting, store of value, medium of exchange). Affected economy reverts to barter (inefficient).

1. Monetarism versus Structuralism…

• Monetarism (Orthodoxy): Supporters believe that inflation is the result of too much money chasing too few goods. They argue that the main cause of inflation is deficit spending financed by money creation. To reduce inflation, they argue that the supply of domestic currency creation must be drastically reduced.

MV = PT

• Structuralism (Heterodoxy): Main the primary reason for inflation has to do with the structure of industrial production. They argue that inflation is brought about when one sector of the industry or economy grows more slowly than the whole (asymmetric development). Sector growth variation creates bottlenecks for those slow growth industries, causing relative price increases (cost push inflation).

[1] example of agriculture….

• There are three main factors supporting the structural argument as a cause of inflation in Latin America:

[1] Export earnings are inadequate to permit relieving shortages by importing sufficient amounts of “bottleneck” products to reduce domestic prices.

[2] Labor markets are neither homogenous nor competitive.

[3] Price increases can be passed along because most markets are at best oligopolistic (too much monopoly power).

• Assuming the structuralist are correct, how should government policy be designed to address high inflation?

• Structuralists recommend income policy and price freezes to combat inflation.

• Assuming the monetarists are correct, what should be the government’s approach be to this problem?

• Fiscal and monetary restraint (conservative).

2. Five contributing factors in the inflation process :

• Seignorage…

• Balance of payments crisis:

[1] Recommended policy action: Devalue the currency.

[2] Yet this can generate an immediate jump in inflation because of falling terms of trade (import prices jump)…”J” curve.

• Dollarization:

[1] People substitute dollars for their domestic currency when inflation increases and confidence in the domestic currency declines.

[2] Similar to capital flight although the flight to the dollar is within the national borders (action led by lower and middle classes).

[3] Velocity rises, becomes unstable and feeds inflation.

• Capacity constraints and supply shocks:

[1] Any shock that increases aggregate demand above full employment output or abruptly decreases aggregate supply contributes to inflationary pressure. (e.g. natural disasters)

• Indexation and policy adjustment intervals:

[1] These policies backward looking: wage adjustments, mini-devaluations, or monetary corrections.

[2] Create inflationary expectations (inertial inflation) … contracts (social and private)…becomes a self-fulfilling prophecy.

[3] what is a tabela or tabla?

3. Policy “trilemma” in the context of economic instability (recession, inflation, high external debt, government deficits, a deficit in the balance of payments & lack of international confidence)… Box 5.1; p. 117

• The “trilemma”: A country can not have strong monetary control, a fixed exchange rate and mobile financial capital simultaneously in this context.

• Question: How much macroeconomic imbalance is tolerable?

a. Domestic monetary policy objective is to shorten recession while restraining inflation.

b. Fixed exchange rate: objective is to create a “price anchor” with major trading partners and to force real adjustment (subdue domestic inflation).

…Yet under a fixed exchange rate regime, a trade deficit results in a decrease in the money supply, weakening monetary freedom to balance domestic economy. At the same time, loose monetary policy to stimulate domestic economy will worsen trade deficit and undermine central bank’s objective of maintaining a pegged exchange rate.

c. Capital mobility: Objective is to encourage foreign direct investment and boost confidence in country while at the same time discouraging capital flight (capital controls can be used for this…yet is a blunt tool that discourages FDI).

• Yet for this domestic interest rates must be equal to international real rates plus domestic inflation premium. If done central bank loses interest rate “wedge” tool of monetary policy.

4. Facing this “trilemma” monetarist advise to abandon domestic monetary policy and link economy to a “hard” international currency.

5. Structuralists advise exchange controls to preserve domestic autonomy. Instead of forfeiting autonomous monetary policy or adopting an exchange anchor, they prefer to restrain capital mobility.

6. Heterodox experiments in Brazil… details in book (pp. 127 – 132)

• Cruzado plan (early 1986)

• Besser plan (mid-1987)

• Collor plan (1990)

• Cardoso’s Real plan (late 1993)… ended 1999… table 5.7 → worked but was in fact a mix of heterodox and orthodox elements.

… Worked because this plan was credible to the public. It was gradual, preannounced and the new currency succeeded in erasing the inflationary memory of the old unit (real…reias)

… Still, since there was a lack of fundamental restructuring of fiscal outlays, government deficits grew. After a mini-crisis in 1998, Cardoso extracted important fiscal reforms from Congress (table 5.7, p. 125).

… Lesson: heterodox policy alone is not enough. Need structural reform along with targeted orthodox policies. “Lula” da Silva since 2002 has done this.

7. Inflation needs to be curbed in Latin America:

• It creates widespread feelings of economic insecurity => produces suspicion as well as reduces support for constitutional governments (feeds into military juntas).

• Disintegrates purchasing power, destroys the integrity of money, reduces economic growth, causes financial market instability and reduces investment.

• Worsens inequality in income and wealth distribution (inflation tax).

• Contributes to capital flight/dollarization.

• Leads to balance of payments problems => decreases foreign direct investment/portfolio investment and increases the burden of servicing external debt (denominated in foreign currency… typically the dollar).

• Undermines government finances and induces seniorage…… and can ultimately transmute into inertial inflation (structural).

• Olivera-Tanzi effect?Real purchasing power of tax collections fall: Current tax payments are made on last year’s income; yet in a high inflation environment those tax collections buy a lot less government services and goods this year than it would have last year. Undermines the efficacy of tax system and encourages more seniorage.

• Velocity of money increases making money supply more difficult to control.Velocity of money increases making money supply more difficult to control.

8. Read about the cases of Bolivia (pp. 128 – 130) and Argentina (pp. 130 – 134) 8. Read about the cases of Bolivia (pp. 128 – 130) and Argentina (pp. 130 – 134) …all important and insightful.…all important and insightful.

• Pay particular attention to the role of an independent “currency board”… free Pay particular attention to the role of an independent “currency board”… free of Treasury/Central Bank control… therefore free to implement new law: of Treasury/Central Bank control… therefore free to implement new law: money supply could only increase if the US dollars held in reserve were to money supply could only increase if the US dollars held in reserve were to rise.rise.

• Note:Note: The ’91 Convertibility Plan (locked peso to the dollar-Argentina) failed The ’91 Convertibility Plan (locked peso to the dollar-Argentina) failed for the same reason the Real Plan failed: growing fiscal and trade deficits in for the same reason the Real Plan failed: growing fiscal and trade deficits in context of dwindling foreign currency reserves (table 5.9, p. 132). context of dwindling foreign currency reserves (table 5.9, p. 132).

Components to inflation reduction:1. Finding a solution to chronic budgetary problems at the core of high inflation.

2. Identifying a means of eliminating inertial inflation, principally wage and price controls and indexation.

3. Introducing one or more nominal anchors to the price level at the start of stabilization to ground expectations and the behavior of central bank authorities.

4. Not necessary but, restructuring the role of government in the economy creates the perception that business as usual has changed (e.g. Brazil under the Real Plan). Boosts confidence both domestically and internationally.

• In the end, without enduring stability there will be no or lackluster growth.

• Instability and the policies necessary to cure it have a price: a growing “social deficit”. It is the poor who suffer most under the ensuing austerity measures. In particular, poor women and children suffer most since mothers are forced out of the home to earn money while children are pulled out of school to take care of the home, watch younger siblings and often to help in the fields. The end result is diminishing “human capital” and reinforcement of the cycle of poverty.

• Therefore, macroeconomic stability is a necessary, but not sufficient, condition for economic development or addressing the “social deficit”.

CChapter #6: The Role of the State: From a Smaller to a Smarter State

• The ultimate objectives for Latin American countries are to be competitive in the international market, achieve sustainable growth and maintain autonomy.

• The crises of the 1980’s and early 1990’s force a reconsideration of the capabilities and role of the state.

• Beyond the important issue of short-term stabilization remain the following long term questions:

1. What size and role should the new, streamlined government assume?

2. What should be the balance between the state and the market in Latin America?

3. How have corruption and poor administrative practices affected the legitimacy of the state in Latin America?

Some important considerations before we move on:

• States that are more open to global trade networks employ greater intervention: globalization may require large states to insulate their citizens from the uncertainty of globalized markets (to promote human development).

World Bank research indicates the following as the fundamental tasks of government:

1. Maintain a non-distortionary policy environment.

2. Invest in basic social services and infrastructure.

3. Protect the vulnerable in society.

4. Protect the environment.

5. Establish a foundation of law (necessary to create transparency and reduce corruption).

Theories of state activity in the context of development:

1. New Political Economy (NPE):

• Based on the assumption of the pursuit of material self-interest and rational calculus of economic participants. The pursuit of self-interest promotes the public good.

• Interfering with the economy and markets should be kept to a minimum.

• Markets work best when goods involved are both excludable, rivalrous and subtractable (notion of a commons).

• Neoliberal agenda (Milton Friedman/Chicago School)

• Washington Consensus based in NPE thinking (John Williamson, 1990…George Sorros: “market fundamentalism”)

2. New Institutional Economics (NIE):

• Focuses on the importance of viable, high-functioning, social institutions.

• Support tenets of individual choice within neoclassical economics yet maintains that mainstream economics ignores transactions costs:

[1] These can be quite high in the context of market failure, structural asymmetry and asymmetric access to information (corruption with limited transparency…”bounded rationality”).

• Argues that economic change is complex and that institutional structure is as important as free markets (interplay of stock of knowledge, institutions and demographic factors).

• Dani Rodrik: 4 functions of economic institutions: Market creating, Market regulating, Market stabilizing, Market legitimizing.

=> Role for selective and effective state intervention in private economy.

• Douglass North’s prescription for successful industrial development:

[1] Secure property rights.

[2] Effective and impartial judicial systems.

[3] Transparent regulatory frameworks.

[4] Healthy institutional arrangements to promote complex interpersonal exchange, including enforcement of contracts, establishment of limited-liability corporations, and easy entry and exit of firms.

• Therefore, markets left to themselves may become inefficient => well structured government institutions are essential to the development of efficient market institutions (you need a well crafted set of the “Rules of the Game”).

3. Neostructuralists…

• The facts describing developing economies do not conform to those of industrial market economies.

• See a broad scope for state activity.

• While placing more emphasis on participation in the global economy, they still support a modified version of dependency theory.

• Call for a “modernization” strategy that responds to socioeconomic backwardness and excessive vulnerability to the global economy.

• Specifically, supports call for the state to promote or simulate missing markets (i.e. capital markets), strengthen incomplete markets (i.e. acquire technology, develop forward/backward linkages), eliminate or correct structural distortions (i.e. concentrations in property ownership) and eradicate or compensate for the most significant market imperfections arising from economies of scale, externalities and asymmetric information.

• Any action taken must be designed to take into account the unique historical legacy of a country and crafted to local conditions (reject the one size fits all strategy that emerges from neoclassical economic theory).

4. Role of corruption (table p. 162)…15%-20% of LA GDP: acts as a tax.

5. Some defining realities:

• Limited capacity to raise revenue to run the state… income tax vs. VAT.

• Privatization… North: Changes in rules must accompany changes in ownership.

[1] Has privatization worked in Latin America?

[2] The “policy pendulum”?

[3] Is the banking sector a special case? (adverse selection & moral hazard?).

[4] What about infrastructure privatization? (e.g. utilities, roadways).

[5] Does privatization necessitate increased regulation and supervision? How does the state pay for this?

[6] Backlash against natural resource privatization.

Special Topic: The Caribbean • The Caribbean is a complex, even enigmatic region, characterized by great disparities in size, population, geography, history, language, religion, race, and politics.

• The Caribbean region is one of the most diverse in the world, with populations varying from 260,000 in Barbados, to 6.7 million in Haiti, 7.5 million in the Dominican Republic, and 10.8 million in Cuba.

• Per capita GDP (2007) ranges from less than $1,400 in Haiti, to more than $29,900 in the Bahamas, the third richest country in the Western Hemisphere.

• Whereas the Dominican Republic and Haiti gained their independence in the first half of the nineteenth century (and Cuba in 1898), the others became independent only in the 1960s (Barbados, Guyana, Jamaica, Trinidad and Tobago) or even the 1970s (the Bahamas and Suriname). • As a result of this colonial past, the region has four different languages, numerous dialects, and a rich ethnic and cultural diversity.

• Primary industries…

1. The Bahamas and Barbados have become dependent mainly on tourism and services.

2. The Dominican Republic and Jamaica, on tourism, mining, and light export manufacturing.

3. Suriname and Guyana rely heavily on mining combined with agriculture.

4. Haiti, on agriculture and light manufacturing.

5. Trinidad and Tobago's mainstay remain the export of oil, oil derivatives, and natural gas-based petrochemicals such as ammonia, urea, and methanol.

6. All the rest rely primarily on tourism with few exceptions (e.g. Cayman Island & Bermuda: off-shore banking)

Recent Economic History…

• Buoyed by strong private and public investment, low global interest rates, favorable terms of trade for regional commodities, and an agile, adaptive labor force, the Caribbean economies achieved substantial real GDP growth rates on average during both the 1960s (4.3 percent) and the 1970s (3.8 percent).

- Per capita real growth was above 2 percent per annum for the region as a whole, and continued progress was made toward political stability.

• For most of the 1980 the region was caught up in the international debt crisis so suffered from low levels of international investment and access to international credit. All economies experienced significantly slower economic growth and growth in per capita GDP stagnated.

- An exception was Trinidad and Tobago, that had an oil boom in the 70’s; a subsequent investment spike, and introduction of the "Dutch disease" into the country, from which it has yet to recover.

• In the 1990s and 2000s, the economies of mature tourist destinations Barbados and the Bahamas were struggling, along with those of non-adjusting Suriname, Haiti, and hydrocarbon exporter Trinidad and Tobago, which remained vulnerable to the long slide in global oil prices (1982 to 2002 with a significant rebound to mid-2008).

• Effects of 9/11…

- Tourism dropped precipitously and then revived about two years later.

- Oil prices renewed the economic fortunes of Aruba (natural gas) and Trinidad and Tobago (reinforced their “Dutch disease”).

Common Characteristics of Caribbean Economies…

• Salient features of most Caribbean countries (with the partial exception of Haiti and the Dominican Republic) are a relatively high degree of formal education of the population; a limited size of the domestic market (small, island economies) and a strong regulatory and locomotive role for the state in the economy (they too got caught up in the ISI strategy of development).

2. A track record of risk aversion and rent-seeking by the local private sector.

3. Declining bargaining power in daily dealings with major trading partners.

4. A relatively good, but progressively outmoded physical infrastructure (particularly critical in Guyana and Suriname, due to years of inadequate maintenance).

5. Last but not least, their economies are extremely open and highly vulnerable to external shocks.

- The regional economies are so open that the weighted average of the sum of exports and imports (trade intensity ratio) oscillated around 80 percent of GDP throughout the 1980s, before sliding to 75 percent in the early 1990s.

- Back up to around 80% of GDP today.

The 1990s and 2000s…

• During the decade of the 90’s the region's economies underwent a formidable transition.

• As the trend towards urbanization continued, employment moved away from agriculture and fisheries towards manufacturing, tourism, and other services.

• Notable exceptions were Guyana, Haiti and Suriname, which lacked the basic prerequisites for rapid development of these sectors.

• Another exception was Trinidad and Tobago, where the oil boom and an ill-designed and implemented public works program led to an exodus from the primary sector in the early 1980s.

• The structure of the region's external debt substantially improved from the mid-1980s to 2000; to the extent that high, mostly variable, interest lending from private banks was progressively replaced by a mix of multilateral and bilateral loans that carry more favorable interest rates in exchange for more stringent conditions on the use of the funds (conditionality again).

• Nevertheless, a number of Caribbean countries, most notably Jamaica, the Dominican Republic, Guyana, Haiti, and even Trinidad and Tobago, experienced difficulties in meeting their external debt servicing obligations.

- After occasionally falling into arrears, they had to rely on special arrangements with the Paris Club (for bilateral and officially guaranteed loans) and the London Club (for private bank loans) to reschedule their obligations to longer maturities and sometimes more favorable terms.

- The Dominican Republic and Guyana were also enabled to use short term bilateral and multilateral funds to buy back a substantial part of their outstanding borrowing from private banks.

• Trends in tourism: The Dominican Republic and Jamaica greatly increased their share in Caribbean tourism, both in terms of foreign exchange revenues and market share.

- In the case of the Dominican Republic, in addition to highly competitive exchange rates, another factor contributing to the massive investment in tourism accommodations was strong government support: one of the

branches of the central bank, for instance, extended substantial amounts of credit to the sector at preferential rates. In addition, tourism revenues and 50 percent of revenues from reinvested profits were exempted from income taxes for a ten year period.

• Furthermore, both the Dominican Republic and Jamaica made remarkable headway between the early 1980s and late 1990s in the development of their EPZ (enterprise zones), which boosted their service balance and strongly contributed to alleviating their pressing unemployment problems.

• Still, it’s important to note that during the 1990s and 2000s only 2 Caribbean nations ran a balance of payments surplus.

• Part of The Dominican Republic and Jamaica success with tourism was due to the fact that they allowed for a sizeable depreciation in their currencies.

- The Bahamas and Barbados, on the other hand, have continued their commitment to staving off the need for depreciating exchange rates by adopting instead austere fiscal and monetary policies, as well as income policies (bad for employment).

The Medium-Term Outlook…

• The international environment in which the region's productive activities will have to operate is characterized by progressively stronger global competition; a process of rapidly increasing technological innovation spurred by advancements in telecommunications; the creation of strong-and possible increasingly exclusive-trade blocs; the globalization of international enterprises and donor fatigue.

• As with Latin American, reform efforts in the Caribbean took an orthodox turn during the 1980s &1990s (time of the “Washington Consensus”).

• CBI in 1980s…NAFTA in 1990s (risks to region…Mexico main beneficiary). Now CAFTA-DR (2004)… with exception of the Dominican Republic the rest of the region will suffer. CBI incentives gradually eroded and it expired in 2007.

• Chances are that the region will increasingly be confronted with demands for bilateral concessions (in the case of replacement of unilateral Caribbean Basin Initiative preferences with bilateral NAFTA/CAFTA conditions), which will harden the terms of external assistance.

• Similarly, new WTO conditions stress trade over aid (Uruguay rounds… loss of protection of textile industry).

• Policies in the United States and the European Union are leading to the reduction in agricultural price supports (mainly bananas and sugar cane).

- This is having a substantial impact on sugar exports, as virtually all the Caribbean countries can only remain operating in this sector at the preferential prices offered in the U.S. and Europe.

• Strong potential for a significant increase in poverty:

- Recent reductions in social expenditures in most regional budgets (orthodox adjustment) raises concern.

- The same goes for the fall in real purchasing power of public sector wages and salaries, particularly in the Dominican Republic, Jamaica, Guyana, and Suriname.

- In these countries it is hard to imagine how the public sector can continue to attract and retain sufficiently qualified professionals at current remuneration levels, and keep them honest and motivated.

- There is a heightened probability of increased emigration of the best and the brightest from the region to other areas in the hemisphere.

• While the future holds formidable challenges for the Caribbean, the region has shown remarkable resilience these past two decades.

• Governments, unions, and the private sector show greater understanding for the need to improve the region's competitive position.

• There are signs that the initially defensive reaction is yielding to a more forward- and outward looking strategic orientation on the region's natural comparative advantages, aimed at defining niches in the international market of goods and services where the region can successfully compete.

Recent Developments:

• On October 15th, 2008 in Barbados, 13 Caribbean countries approved a new Economic Partnership Agreement (EPA) with the European Union.

• The EPA involves only gradual changes to a trading relationship which goes back to colonial days. It grants almost all Caribbean exports duty-free and quota-free access to Europe. In return, the Caribbean will phase out duties on 87% of European imports by 2033.

• Until last year these countries have had one-way access to European market (since 1975 under the Lomé Convention, and its successor, the Cotonou agreement).

• Pattern of trade relations between Europe and the Caribbean was no longer in synch with the rules of the WTO.

• The agreement will help the Caribbean to develop new exports, and to rely less on old staples like bananas and sugar.

• US is still the largest trading partner with, and investor in, the region.

• Still, the most dynamic business opportunities in the coming decade will be between countries in the region and the EU.

• The big story for 2010 may be Cuba:

• The Obama administration is relaxing travel and financial restrictions for US citizens...but will keep the trade ban in place for now.

• Once Cuba re-enters the hemispheric trade world, regional competition is likely to further increase, not only in sugar, but also in rice, vegetables and citrus, tourism, services, and manufacturing.

Trade between US and Caribbean Countries

Millions of US $ (2007) Export Import

Antigua and Barbuda $240 $9

Bahamas $2,473 $523

Barbados $457 $40

Belize $234 $113

Dominica $84 $2

Grenada $83 $9

Guyana $188 $147

Jamaica $2,318 $789

St. Kitts and Nevis $203 $61

St. Lucia $166 $36

St. Vincent and Grenadines

$69 $1

Suriname $306 $136

Trinidad and Tobago $1,779 $9,342

Dominican Republic $6,091 $4,328

Haiti $711 $500

Cuba $447 $0

Aruba $529 $3,070

Bermuda $660 $24

Netherlands Antilles $2,082 $810

• The Caribbean region as a whole is not yet doing as well as it could and should.

- Too much tension still prevails between public and private sectors, between employees and employers, between export orientation and import substitution, and, last but not least, between the desire to preserve current standards of living and the economic imperative to devote resources to generating productive employment for future generations.

• As the world economy makes a quantum leap towards integration, the region must take a final, hard look at the conditions, policies, regulations, and institutional arrangements that could inhibit future growth.

• With the combined forces of the national governments and private sectors, and efficient use of available external assistance, especially to invest in its human resources, the Caribbean region can be trusted to make the mental transition from the aid to the trade mode, which is the precondition for the advancement and prosperity of its future generations.

Chapter #7: New International Capital Flows: The Benefits (and Hidden Costs) of Latin America’s Return to Markets

Chapter deals with a series of important questions:

1. Why has capital returned with such intensity to the region?

2. How do the different kinds of capital… short and long-term portfolio investments as well as long-term foreign direct investment (FDI) through multinational corporations … affect development prospects in the region?

3. Does this new reliance on international capital make Latin America vulnerable once again to swings in global markets?

4. Are there ways of minimizing vulnerability while maintaining the confidence of international capital?

Facts:

• Figure 7.1 indicates that there had been a huge increase in capital flows to Latin America between 1991 and 2001. Since that time LA has become a net capital exporter (began with crisis in Argentina).

• Flows are concentrated in a few counties: 75% went to 12 countries while 50 countries received virtually none.

• Official aid flows to all poorer counties has dropped (in 2000 they were 1/3 of what they were in 1990). Reason: End of Cold War.

• Remember that while Latin America has become a good investment risk, international capital chooses a home based on relative appeal: opportunity for profits must exceed the expected return adjusted for uncertainty and risk (transparency & corruption) everywhere else (e.g. China). Π ≥ F

• Also, low wages are not in themselves a draw: The key is total compensation per unit of output. Labor legislation can significantly raise total compensation cost. Also, there is no advantage in low wages if they come with low productivity.

• The US remains the principal investor in the region, concentrating on manufacturers in Mexico and services such as electricity and gas distribution and telecoms in Mercosur (52.5% of FDI).

• Northern European firms (plus Spain) are a growing presence. Concentrated in Mercosur and Chile in the following industries: telecoms, energy, financial services, automotive, agro-industry, and retail trade.

• Spain has move aggressively into the region during the last 15 years. Had a large presence in Argentina and was hit hard by their 2002 crisis.

• Reasons for the increase…

1. Global economic integration as brought with it wider, deeper and more sophisticated financial markets.

2. Technology has reduced the transactions costs associated with capital transfer making allocation both speedier and more efficient.

3. New groups of institutional investors have come into global financial markets… pension, hedge and insurance funds.

4. The inversion of the population pyramid in the developed countries brings a flood of retirement money into the global market in search of returns.

5. Increase confidence in the region, that the changes made in the 1990s are permanent: increased confidence.

• Financial flows into region take six forms…

1. Foreign direct investment

2. Portfolio bond purchases (denominated in dollars, euros or yen)

3. Portfolio equity flows

4. Loans

5. Lending directly to support trade (bank letters of credit that provide financing for exports in transit until the importer pays for the goods, as well as commercial bank lending).

6. Remittances

• Figure 7.3 shows the proportions of each as well as the incredible increase across time… note that FDI is the largest category.

• What are “depository receipts”… hint: they are part of equity investment.

• Short-term capital (committed for less than 1 year) with the exception of loans to finance trade is broadly characterized as speculative or “hot” money and is the category that concerns domestic policymakers most.

• “Bandwagon” and “herding” effects => makes flows procyclical.

Role of Multinational Corporations:

• FDI associated with them and, from a domestic point of view, is less risky than borrowing because if the project fails it is foreign shareholders rather than citizens that bear the cost.

• In terms of annual sales, which is the largest multinational corporation operating in Latin America?

• Box 7.2… lists the “Pros” and “Cons” of having a multinational corporation operating in a developing country.

… again, what on these lists dominate depend on the country and MNC in question.

• Still, in general the question remains: Does the surge in MNC’s investment improve the productive capabilities on Latin American economies?

… one study of foreign production in Mexico shows that a high MNC presence is correlated with an increase in productivity in locally owned firms and that the rate of catch-up with international productivity standards is positively associated with the degree of foreign concentration in the industry (spillover effect).

Spillover efficiency effects are strong… at least in Mexico.

International capital flows and domestic banking…

Characteristic of a “sound” banking system… if domestic investors decide to sell long-term financial assets they can move into domestic bank deposits for security. Prerequisite for deepening of capital markets…along with sound legal system, efficient clearing and settlement system, transparent accounting and proper regulation.

Therefore, strong banking system can reduce macroeconomic instability.

This increases the availability of funds making it easier for banks to lend to companies.

• Thus, expansion is encouraged, counteracting an economic downward trend.

• However, if there is a lack of confidence in the banking sector, the alternative is capital flight.

… when the banks fail to provide domestic intermediation the effects of crises are magnified.

• This was the state of things in the early 1990s (and before).

… years of capital controls left over from the 1980s had weakened the banking sector: restricting competition and retarding technological advances with most banking relationships being defined by personal or political ties.

• Institutional change and development began during the early 1990s in the banking sectors yet it has been slow…and created new problems.

Characteristics:

1. The speed of privatization led to improper asset valuation, sloppy accounting and a tendency toward political expediency in sales.

2. It also led to excessive concentration of power in a few bank’s hands.

3. Foreign banks have moved rapidly into the region: Banco Santander, Citibank, Banco Bilbao and Credit Suisse.

• Like in the previous chapter, deepening financial markets requires macroeconomic stability, a sound legal framework, an efficient clearing and settlement system, a transparent accounting system, an efficient market for trading securities and a proper regulator and supervisory framework (all reduce transactions costs).

• The Mexican Peso Crisis… covered earlier yet pay attention to discussion on this equation: C/y = gk*

A measure of current account sustainability… Where…

C = current account

y = gross domestic product

g = real growth rate of economy

k* = parameter determined by investors’ assessment of the risk involved in holding securities as well as the difference in expected returns between investments domestically and abroad (% of liabilities foreigners willing to hold).

• If the current account deficit is equal to 2% of GDP (i.e. C/y = 2%) and the economy is growing at a 4% rate (g) then k* = .5 => foreigners are interested in holding liabilities equal to 50% of GDP. Also, the economy can comfortably run a trade deficit of 2%

• This is similar to what was happening to Mexico in the early ’90s… but Mexico was running a current account deficit of 8% of GDP! Therefore, deficits were too high relative to international investors’ willingness to expose themselves to that nation's financial instruments.

… The government ignored the warning signs, permitting an overvaluation of the exchange rate on the order of 30%. Eventually, due to the imbalance, international capital began to vote with its feet (short-term assessment of k* changed rapidly). In the short term intermediate financial capital moves faster than trade patterns can adjust so Mexico found itself in the position of rapidly dwindling international reserves => crisis of early 1994.

… Made worse by the fact that the initial devaluation was announced in a policy vacuum, creating a panic disproportionate to the underlying fundamentals in the economy => “tequila effect” created regional pressure.

• Read about Chilean case in the ’90’s: dark side of good policies and successful adjustment => exchange rate rose which undermined the export sector (retard a source of import economic dynamism). Chile: Export Development Model.

The Asian Economic Crisis & the Contagion Effect in Latin America…

• Summer of 1997 saw a currency crisis among the Asian Tigers.

• Despite nearly two decades of adjustment, regional economies were challenged by a global loss of investor confidence in developing economies.

• Meltdown of stock and bond markets unrelated to underlying economic fundamentals….Brazilian Real fell a further 20% (price shock)

Lessons:

1. International capital flows can be fickle in nature…and they are becoming more complex (both in players and instruments).

2. There is a need to promote stable domestic growth and find ways to depend less on the externally driven development model. Boost savings!

3. FDI must be translated into real gains in productivity if capital inflows are to remain stable (promote tradable goods [exports] over nontradables).

4. Governments need to decrease consumption in favor of domestic savings (reduce reliance on capital inflows)

5. It may be that the architecture of the global economy needs to change (IMF is too weak, may need a mechanism to permit sovereign bankruptcy and redefine conditionality to be more flexible…and we may need a new reserve currency).

• What is a Tobin Tax?

6. Remittances: greater than FDI…over $50 billion a year from 25 million Latin Americans working outside region

• Boosts growth, contribute to macroeconomic stability, ease impact of adverse shocks and reduces poverty.

• Banamex credit card…means to get money to relatives in Mexico (concept rapidly spreading through Latin America).

7. Official Development Assistance:

• Helps bridge gap between local resources and developmental needs.

• Mainly takes form of grants over loans (80%)…external debt reduction initiatives rising in importance.

• Still, net aid flows per capita are low ($10 as opposed to $13 elsewhere in world)

• 25% through World Bank and IADB…rest is bilateral (e.g. USAID)

• Post Cold War: less money and more focused on poorer countries in region (Haiti, Nicaragua, Honduras, Bolivia).

Chapter #8: Contemporary Trade Policy: Engine or Breaks for Growth?

1. Levels of economic integration:

• Free trade area – each member has their own trade barriers (tariffs/quotas/regulations) with non-member nations yet have none between members. (e.g. NAFTA, CAFTA)

• Customs union – uniform trade barriers with non-members. (e.g. Mercosur)

• Common market – free flow of factors of production between member nations (EU).

• Economic and monetary union – Supranational institutions power increases … common currency. (e.g. the Euro Zone)

• Full economic integration – unified government. (e.g. USA)

Note: Your author only gives 4, combining the last two under “Economic Union”.

2. Economic effects resulting from economic integration:

• Trade creation – elimination of trade barriers generate gains => increasing the volume of imports from member nations – each country concentrates more on producing the goods in which it has a comparative advantage relative to other member nations (trade and GDP expands).

• Trade diversion – trade diverted away form lower-cost, non-member nation producers toward higher-cost member nation producers. Necessarily inefficient since purchase is made from a higher cost producer.

• After the ISI period drew to a close and the debt crisis period that began in the 1980s abated, increased globalization of trade, finance, and production came to define the international agenda.

• Latin America was dragged into an external orientation which has come to be seen as the only strategy compatible with global trends.

The theoretical benefits of freer trade:

1. Theory of comparative advantage…focuses on relative labor costs.

2. Heckscher-Ohlin theorem (labor and capital): factor proportions determine the direction of trade….. A country relatively well endowed with capital should produce and export capital intensive goods, one well endowed with labor should produce and export labor intensive goods, one endowed with natural resources should export primary intensive goods (relative costs).

3. Stolper-Samuelson effect: if a labor-abundant country produces cheap labor-intensive goods, over time the increase international demand for these goods will raise their price and by association the price of their key input: labor.

• Stolper-Samuelson effect => trade will in time benefit the least well-off…. The poor workers.

3. Factor price equalization theorem: over time wages will rise in labor-abundant countries and fall in capital-rich countries => international prices of labor and capital will each converge (idea behind PPP & Convergence Hypothesis).

4. Other theoretical work by Krugman suggests that once a country opens itself up to trade there will be a period in which inequality will increase, followed by a period in which the Stolper-Samuelson effect will assert itself and inequality will decline (importance of growing middle class with increasing political power).

5. Empirical work conducted by the World Bank for the 1970-1990 period show that those countries with open trade regimes grew at a 5.0% per capita rate. Nonglobalizing developing countries struggled through this period with a 1.4% per capita growth rate (David Dollar)=> trade does seem to create higher growth (but not necessarily development [Rodriguez & Rodrik]).

6. Trade theory does not predict which country will gain in a trade relationship and it’s important to remember that those who come to the bargaining table are not all equal in power. Neostructuralist generally believe that powerful industrialized countries and powerful MNCs accrue a disproportional share of the gains from trade.

• Remember that it was the perceived failure of free trade that led to adoption of the ISI strategy throughout the region.

Along with the aforementioned problem with unequal distribution of the gains from trade, there are two other problems noted in the book:

1. Environmental dimension… slash and burn agriculture that leads to reduction in rain forests, strip mining, for instance, as well as becoming the dumping ground for the toxic waste of the first world.

2. Gender effects… exploitation of cheap female labor. Women have a double obligation in the home and in the factory putting stress on the family, undermining their ability to organize and perpetuating low wages and poor working conditions.

Still, others argue that in the long run a nation will gain by its openness and point out other gains from freer trade than those defined in the law of comparative advantage. Specifically, it is argued that openness to trade brings…

1. Better access to technologies, inputs to production, and a wider array of intermediate and final goods.

2. Producing for the international market permits domestic firms to take advantage of economies to scale.

3. Opening borders to the influx of new products and investment by MNCs encourages competition in the domestic market plus increases local skills.

4. Finally, studies have shown that improvements in productivity rates correlated with periods of liberalization in Latin America.

But the question remains: How should liberalization be implemented?

• “No country has grown over time by turning their back on trade and capital flows. However, simply opening up to trade without building institutions to manage its social and environmental costs is a risky approach.”

• Short-run costs to liberalization: Inefficient firms are decimated, throwing large numbers of employees out of work.

• Argument has been raging since the early ’90s on how quickly a country should liberalize (shock therapy vs. gradualism).

1. One school of thought: Domestic industries should gradually adapt to international price signals, giving them time to modernize and become more efficient (neo-structuralists).

2. Another school of thought (Shock Therapy, Jeffery Sachs): Get the transformation over quickly so that a nation gets through the painful transition quickly while there’s popular support and political will (neoliberals; old IMF).

• Some research suggests that a gradual, staged process of liberalization works best (China vs. USSR). This approach permits…

1. Introduction and adjustment of a package of policies to maximize benefits (including fiscal reform).

2. Permits an appropriate exchange rate to be determined.

3. Permits short-term incentives from the state for export promotion to be effective (including establishing trade missions).

4. Allows for the development of a supportive institutional framework.

The record of liberalization in Latin America:

• Average tariff rates in Latin America declined from nearly 50% in 1985 to just above 10% today. This transformation was gradual yet set off surge in exports: but imports surged too so trade balance problem still with them.

• Star performers so far have been Brazil, Costa Rica, Mexico, Chile and El Salvador.

• Read her discussion on performance and the composition of goods: pp. 247-249 (greatest diversification in Mercosur countries).

• In terms of the exchange rate Latin America has had a limited ability to use it to vigorously support export promotion because of the need to fight inflation, chronic current account deficits and the strong US dollar (1982 – 2002).

• Still, in the early 2000s, most countries experienced sweeping changes in exchange rate regimes with most counties moving to a floating exchange rate systems.

Regional Trading Arrangements…

• Over the past 15 years, the Economic Commission for Latin America and the Caribbean (ECLAC) has embraced a concept called “open regionalism.”

• Idea is to join regional integration with overall liberalization of trade barriers to nonmember countries.

1. NAFTA… signed in 1994 between the US, Canada and Mexico.

• Incorporated the gradual elimination of tariffs over a 10-year period.

• Intellectual property rights were also strengthened.

• To prevent abuse the legislation includes tough rules of origin specifying what proportion of the value of a product must be added locally and imposing strict domestic content rules of the purchase of inputs.

• Unlike the EU (a common market) there is no provision for the free flow of labor between member countries.

• Note: the only sectors where NAFTA explicitly benefits Mexico are concessions in the US market for fruit, textiles and clothing.

• The US retained significant advantages in certain key industrial markets, such as telecommunications and services.

• Signing of NAFTA was very controversial. In the US conservative politicians and labor unions formed an uneasy alliance to fight its passage.

• NAFTA… and now CAFTA… represent a neo-liberal model of trade agreement. Open trade without instituting mechanisms to ease transition or common rules and regulations (e.g. labor, environment).

• It did seem to pump up the Mexican maquiladora sectors (A twin-plan program set up in 1965 that allows foreign firms to import components without duty so long as the final product is reexported). Still, NAFTA did not have a dramatic impact here since Mexico’s share of US FDI declined in the ’90s after the treaty was signed.

• While the jury is still out on the overall effects of NAFTA (difficult to separate out various effects), since 1991 NAFTA has created more than $250 billion in trade between the US and Mexico each year. And much of this has been trade creation, not diversion.

• The spirit of NAFTA has worked to encourage both business confidence and a willingness to work together on bilateral issues.

• Beyond NAFTA, many other free trade agreements were signed in the 1990s: Table 8.11… and many more are on there way in the 2000s: e.g. CAFTA

2. MERCOSUR (Mercado del sur)

• The second largest trading agreement in the Western Hemisphere after NAFTA

• Signed by Argentina and Brazil in July 1986 to promote industrial integration.

• Full members today in addition to Argentina and Brazil: Uruguay and Paraguay (Treaty of Asuncion, 1991)

• Associate members: Chile, Bolivia, Columbia, Ecuador, Peru & Venezuela.

• Mercosur ranks 3rd among trading blocs in the world with more than $750 billion in GDP and 220 million inhabitants. Trade among the member states has quadrupled since 1990 with over $20 billion in regional trade today.

• In 1999 Mercosur members began talks with the EU to form an expanded free trade area that could edge out the US.

… we have already seen that European MNCs have been active in the region with bilateral trade flows growing to in excess of $50 billion.

• Administratively, Mercosur is governed by six institutions run by a council composed of the foreign relations and economic ministers of the four member states.

• Mercosur has achieved a customs union but is not a common market.

• Achieving a customs union was slated for 2006, yet this was contingent on the members making progress in the coordination of economic, legislative, environmental, infrastructure, and technological polices (not done…date moved).

• All of this has been complicated by first the Brazil Real crisis of 1999 and the slow simmering Argentine crises that came to a head in 2002.

• Note: the US is still the number one trading partner for each country in Mercosur. Given trends, this will likely change in the next decade or two.

3. Other regional trading agreements…

• Read about the Andean Community, Central America Common Market.

• Comments on CAFTA (rules of origin) & US model for inter-regional trade (bilateralism).

• Puebla a Panama Plan (Mexico, Fox…picked up recently by Caldaron)

4. Toward a Hemispheric Free Trade Agreement…

• Free Trade Area of the Americas (FTAA)

• Member countries account for 45% of US trade… the largest regional percentage of US trade.

• US is particularly interested in oil imports from the region.

• Idea behind FTAA: consolidation of nearly 15 free trade pacts already in place in the region.

• 9/11 derailed support and progress in US.

• Inter-American Development Bank (IADB) has argued that for a FTAA to proceed, a second generation of structural reforms must take place in such areas as education, pensions, health, modernizations of state and financial regulations.

• Without these, the region will not be competitive and therefore will be unable to capture a fair share of the gains from such an agreement.

• Last major meeting on a FTAA: 2001 “Quebec Plan of Action”

• Regardless, we will be hearing more about this in the future and the initiatives taken so far at the least indicate a willingness to pursue a new economic and social agenda. For the time being, bi-lateral trade negotiations and agreements will be the norm.

5. Doha Development Agenda (2001): Central element is to lower the trade barriers that developed countries place in the way of developing countries.

• Little progress with effort stalled in face of current global economic downturn.

Special Topic #3: Brazil

Brazil 2005 2006 2007 2008 2009 2010 2011

Nominal GDP (US$ bn) 881.8 1,088.90 1,366.30 1,637.90 1,573.40 1,887.70 1,918.20

Real GDP growth (%) 3.1 3.9 6.1 5.1 -0.2 5.5 4.5

Population (m) 184.2 186.8 189.3 191.9 194.4 196.8 199.3

GDP per head (US$ at PPP) 8,606 9,108 9,802 10,387 10,365 10,951 11,447

Public-sector balance -3 -2.9 -2.8 -2 -3.3 -2.4 -2

Net public debt 46.7 45 42 38.8 41.6 41.4 39.7

Consumer prices (end-period; %) 5.7 3.1 4.5 5.9 4.3 5.3 4.5

Trade balance 44,703 46,457 40,032 24,836 25,347 6,579 -2,155

External debt (US$ m) 187,431 193,516 237,472 261,379 279,679 292,554 299,713

• For the past century Brazil has been seen as a land of potential and promise.

• Military coups, statist politics and chronic instability arrested this potential.

• But no more…

1. In the face of the worst global recession since the 1930s Brazil only shrank .2% in 2009 and may grow as fast at 6% in 2010.

2. Brazil is the largest economy in Latin America, the 10th largest in the world and the first of the BRICs (Goldman Sachs).

• Brazil has turned the corner, may become the 4th largest economy in the world by 2050 yet faces enormous challenges:

1. These include high crime and inequality, a weak rule of law, a crumbling physical infrastructure, a highly-restrictive labor code, onerous regulation, a big government (20% of GDP…15% for US), pervasive corruption, poorly funded public education and a massive underground economy (40% of GDP).

2. 2007 discovery of mammoth new oil beds off the Atlantic coast will help by generating billions in new revenue in the coming decades.

• In 1977, Brazilian president Emesto Geisel stated that progress was based on "an integrated process of political, social, and economic development." Democracy, he argued, was the first necessity in the political arena. But democracy could only be achieved "if we also further social development .... if we raise the standard of living of Brazilians." The standard of living, he continued, "can only be raised through economic development.“

• This underscores one of the major themes of this semester: There is a significant difference between economic growth and economic development.

• The tension among modernization, social equity, and order and liberty was first obvious in the early 1920s, when politically isolated middle-class groups united with junior military officers (tenentes) to challenge an entrenched ruling class of coffee-plantation owners.

• By the mid-1920s, the tenentes, bent on far-reaching reforms, conceived a new role for themselves. With a faith that bordered at times on the mystical and a philosophy that embraced change in the vaguest of terms, they felt that only the military could shake Brazil from its lethargy and force it to modernize.

• Their program demanded the ouster of conservative, tradition-minded politicians; an economic transformation of the nation; and, eventually, a return to strong, centralized constitutional rule.

•The tenentes also proposed labor reforms that included official recognition of trade unions, a minimum wage and maximum work week, restraints on child labor, land reform, nationalization of natural resources, and a radical expansion of educational facilities.

• Although the tenentes were frustrated in their attempts to mold policy, many of their reforms were taken up by Getulio Vargas (1937-1945), who seized power in the 1930s and imposed a strong, authoritarian state on Brazil.

• In some respects, the goals of the tenentes were echoed in the revolution of 1964, when a broad coalition of civilians, frustrated by an economy that seemed to be disintegrating, concerned with the "leftist" slant of the government of Joao Goulart, and worried about a social revolution that might well challenge the status and prestige of the wealthy and the middle classes—called on the military to impose order on the country.

• The military leaders foresaw change but believed that it would be dictated from above. Government was highly centralized, the traditional parties were virtually frozen out of the political process, and the military and police ruthlessly purged Brazil of elements considered "leftist" or "subversive." (The terms were used interchangeably.) Order and authority triumphed over liberty and freedom. The press was muzzled, and human-rights abuses were rampant.

• Brazil's economic recovery eventually began to receive attention. The military gave economic growth and national security priority over social programs and political liberalization. Until the effects of the oil crisis in 1973 began to be felt, the recovery of the Brazilian economy was dubbed a "miracle," with growth rates averaging 10 percent a year (all under ISI policies).

• Brazil's industrialization was flawed at this time: It was heavily dependent on foreign investment, foreign technology, and foreign markets. It required large investments in machinery and equipment but needed little labor, and it damaged the environment through pollution of the rivers and air around industrial centers. Agriculture was neglected to the point that even basic food-stuffs had to be imported (asymmetric development…deep structural problems).

• The stress on industrialization tremendously increased rural-to-urban migration and complicated the government's ability to keep up with the expanded need for public health and social services. In 1970, nearly 56 percent of the population were concentrated in urban areas; by the late 1990s, 79 percent of the population were so classified.

• The pressure of the poor on the cities, severe shortages of staple foods, and growing tension in rural areas over access to the land forced the government to act. In 1985, the civilian government of Jose Samey announced an agrarian-reform plan to distribute millions of acres of unused private land to peasants (post-debt crisis).

• 1974 was a crucial year for the military government of Brazil. The virtual elimination of the urban-guerrilla threat challenged the argument that democratic institutions could not be restored be cause of national security concerns.

• Many middle- and upper-class Brazilians were frightened by the huge state controlled sector in the economy that has been carved out by the generals. The military's determination to promote the rapid development of the nation's resources, to control all industries deemed vital to the nation's security, and to compete with multinational corporations concerned Brazilian businesspeople, who saw their role in the economy decreasing.

• Challenges to the military regime also came from the Roman Catholic Church, which attacked the government for its brutal violations of human rights and constantly called for economic and social justice (time of liberation theology).

• The relaxation of political repression was heralded by two laws passed in 1979. The Amnesty Bill allowed for the return of hundreds of political exiles; the Party Reform Bill in essence reconstructed Brazilian politics. Under the provisions of the Party Reform Bill, new political parties could be established—provided they were represented in nine states and in 20 percent of the counties of those states (Communist parties were not legal until 1985)

• Organized labor is important in Brazil. For Brazilian workers since the 1930s, the state has been their "patron," the source of benefits. This dependence on the government, deeply rooted in Portuguese political culture, re-placed the formation of a more independent labor movement and minimized industrial conflict. The state played the role of mediator between workers and management. President Vargas led the workers to believe that the state was the best protector of their interests. (Polls have indicated that Brazilian workers still cling to this belief)

• The abertura (political liberalization) of Brazil climaxed in January 1985 with the election of President Sarney, a civilian, following 21 years of military rule. Importantly, the Brazilian military promised to respect the Constitution and promised a policy of nonintervention in the political process.

• President Sarney in an effort to keep labor loyal to the government, sought the support of union leaders for a proposal to create a national pact with businesspeople, workers, and his government.

• But pervasive corruption, inefficient government, and a continuing economic crisis eventually eroded the legitimacy of the elites and favored nontraditional parties in the 1989 election. The candidacy of Luiz Inacio Lula da Silva, popularly known as Lula and leader of the Workers' Party, "was stunning evidence of the Brazilian electorate's dissatisfaction with the conduct of the country's transition to democracy and with the political class in general." He lost the election by a very narrow margin. In 2002, he won the election and promised to "end hunger."

• The military, despite persistent rumors of a possible coup, has to date allowed the constitutional process to dictate events. For the first time, most civilians do not see the generals as part of the solution to political shortcomings. And Congress, to its credit, has chosen to act responsibly and not be "bought off by the executive office (who has the most power in the government).

Social & Environmental Issues…

• Closely related to the destruction of Brazil's Indians is the destruction of the tropical rain forests. The burning of the forests by peasants clearing land in the traditional slash-and-bum method, or by developers and landowners constructing dams or converting forest to pasture, has become a source of worldwide concern and controversy.

• The massive annual burning (equivalent in one recent year to the size of Kansas) also fuels the debate on the green-house effect and global warming.

• Major changes in Brazilian households have occurred over the last decade as the number of women in the workforce has dramatically increased. In 1990, just over 35 percent of women were in the workforce, and the number was expected to grow. As a result, many women are limiting the size of their families. More than 20 percent use birth-control pills, and Brazil is second only to China in the percentage of women who have been sterilized.

• The traditional family of 5.0 or more children has shrunk to an average of 3.4. With two wage earners, the standard of living has risen slightly for some families. Many homes now have electricity and running water.

• The uneven character of education has been a major factor in the maintenance of a society that is profoundly unequal. The provision of basic health needs remains poor, and land reform is a perennial issue.

• Children are in many cases denied basic rights. According to official statistics, almost 18 percent of children between the ages of 10 and 14 are in the labor force, and they often work in unhealthy or dangerous environments. Violence against urban street children has reached frightening proportions. Between January and June 1992, 167 minors were killed in Rio de Janeiro; 306 were murdered in Sao Paulo over the first seven months of the year. In July 1993, the massacre in a single night of seven street children in Rio de Janeiro resulted, for a time, in cries for an investigation of the matter.

• Scholars continue to debate the actual status of blacks in Brazil. Not long ago, an elected black member of Brazil's federal Congress blasted Brazilians for their racism. However, argues historian Bradford Burns, Brazil probably has less racial tension and prejudice than other multiracial societies. A more formidable barrier, Bums says, may well be “class status”.

• "Class membership depends on a wide variety of factors and their combination: income, family history and/or connections, education, social behavior, tastes in housing, food and dress, as well as appearance, personality and talent." But, he notes, "The upper class traditionally has been and still remains mainly white, the lower class principally colored."

• If Brazil's Indian and environmental policies leave much to be desired, its foreign policy has won it respect throughout much of Latin America and the developing world. Cuba, Central America, Angola, and Mozambique seemed far less threatening during the cold war to the Brazilian government than they did to Washington. Brazil is more concerned about its energy needs, capital requirements, and trade opportunities. Its foreign policy, in short, is one of pragmatism (China).

Economic Policy and Issues…

• In mid-1993, Finance Minister Femando Henrique Cardoso announced a plan to restore life to an economy in shambles. The so-called Real Plan, which pegged the new Brazilian currency (the Real) to the dollar, brought an end to hyperinflation and won Cardoso enough popularity to carry him to the presidency. Inflation, which had raged at a rate of 45 percent per month in July 1994, was only 2 percent per month in February 1995. His two-to-one victory in elections in October 1994 was the most one-sided win since 1945.

• President Cardoso transformed the economy through carefully conceived and brilliantly executed constitutional reforms. A renovated tax system, an overhauled social-security program, and extensive privatization of state-owned enterprises were supported by a new generation of legislators pledged to support broad-based reform.

• But, as was the case in much of Latin America in 1995, Mexico's financial crisis spread quickly to affect Brazil's economy, in large measure because foreign investors were unable to distinguish between Mexico and other Latin American nations.

• A similar problem occurred in 1998 with the collapse of Asian financial markets. Again, foreign investors shied away from Brazil's economy, and President Cardoso was forced to back away from a promise not to devalue the real. With devaluation in 1999 and signs of recovery in Asian markets, Brazil's economic prospects brightened considerably. Exports rose, and Brazil was able to finance its foreign debt through bond issues.

• In 2000 and 2001, however, the economy slowed, and concerns were expressed about energy supplies and costs, and the default of Brazil's major trading partner, Argentina, on its foreign debt. Economic uncertainty emboldened Congress to initiate a probe against corruption in government. Life for average Brazilians remained difficult.

• Cardoso's loss of popularity opened the door to the political opposition who were able to capitalize on presidential elections in 2002, when Luis Inacio da Silva won a resounding triumph at the polls.

• Lula, who worried many foreign observers because of his "leftist" ideology has begun to tackle Brazil's myriad problems in a pragmatic fashion. Labor unions, who supported his presidency and expected all of the benefits of political patronage, have been somewhat disillusioned. Lula, in attempt to bring the nation's spending under control, significantly culled the public work force. With regard to the economy, his policies have not been "leftist" but have more closely adhered to orthodox economic approaches. This has calmed the fears of foreign investors.

• The wealth of the nation still remains in the hands of a few, and the educational system has failed to absorb and train as many citizens as it should. Police continue routinely to abuse their power. Lula, who's own family roots lie in the favelas, is deeply sensitive to the needs of Brazil's poor and disadvantaged. He has made a point of visiting the slums, of listening to the complaints and needs of people, of behaving, in short, like the classic Latin American "patron".

• At a broader level, Brazil has prospered from its membership in Mercosur and the post-1995 surge in the global economy.

• Lula, like Cardoso before him, is opposed to Washington's efforts to forge a Free Trade Area of the Americas (FTAA), in part because Mercosur and Brazil consider Europe a more important market and do not send as high of a percentage of their exports to the United States as other LA countries.

• Brazil has kept the pressure on other South American governments to convince them to join with Mercosur, not only in a "South American Free Trade Agreement", but in closer ties with the European Union. This independent policy has provided Brazil with leverage in the era of globalization.

• With regard to foreign policy, Brazil has made common cause with other populist or independent-countries in South America, much to the consternation of the U.S. Lula has a warm relationship with Venezuela's Hugo Chavez and Cuba's Fidel Castro.

• He has strongly attacked the United States' invasion of Iraq: Standing up to the United States plays well at home and has boosted his popularity.

Outlook for 2010-11

• The favorable economic outlook and the high popularity of the president, Luiz Inácio Lula da Silva, bode well for the ability of the ruling Partido dos Trabalhadores (PT) to secure a third consecutive term in the October election.

• With legislative fragmentation set to persist, prospects for structural reform will remain dim under either Dilma Rousseff, the PT's candidate, or José Serra, the candidate of the Partido da Social Democracia Brasileira (PSDB).

• Unlike Ms Rousseff, Mr. Serra would be unlikely to favour a state-led development model, but would be more prone to deviate, if not radically, from macroeconomic orthodoxy.

• Strong economic data for January-February have prompted a revision of GDP forecasts for 2010 from 5% to 5.5%. In 2011 weaker US and Chinese growth, and domestic policy tightening, will dampen Brazil's growth to 4.5%.

• The recent announcement of a spending freeze equivalent to 0.5% of GDP has led to a slight upward revision to the 2010 primary surplus forecast, but many expect it to fall short of the target in both 2010 and 2011.

• More widespread price pressures driven by strong domestic demand have prompted a revision of forecasts for consumer price inflation at end-2010 from 4.8% to 5.3%, before falling to 4.5% in 2011.

• The current-account deficit as a share of GDP will more than double by the end of 2011, as the trade balance goes into deficit, but this assumes substantial foreign direct investment (FDI) inflows.

President Luiz Inacio Lula da Silva with Dilma Rouseff, his chief of staff and the Worker’s Party’s presidential candidate for 2010.

Chapter #15: Lessons Learned: Cycles in Latin American Development

• Over the past several decades the region has gone from one dominated by repressive military regimes and economic inwardness to one dominate by democracy and economic openness.

• Unfortunately, the change has not had a measurable impact on economic development in the region.

… in fact, by many measures Latin Americans are worse off today than they were under ISI in the late 1970s.

• 60% of Latin Americans think their economy is in trouble, and 70% see no hope for improvement in the near future.

• 65% perceive themselves as poorer today than five years ago, and 86% believe income distribution is unjust.

• 66% are dissatisfied with the results of democracy.

• The news, though, is not entirely bad: after a decade and a half of reform, many Latin American nations have made significant progress in moving onto a sustainable development path.

• Still, your book points out that the gains will accrue only over time.

The Economic Laboratory of Latin America…

• For the past half century, Latin America has been a virtual economic laboratory.

• First ISI, then the “muddling through” of the debt crisis to the orthodox policies of the IMF to the heterodox experiments of various countries as well as the ongoing neo-institutionalism initiatives.

• There are significant individual country experiments ranging from Cuba’s communist regime to Chile’s “Chicago Boys” policies.

• More than in any other region of the world, NGOs have stepped into the more open post-1980’s debt environment to push their own regional agendas (big in environmental, labor and sustainable development arenas).

Addressing the Social Deficit…

• While finding their way in the rapidly changing global economy, the Latin American state has had to figure out how to do more with less.

• More money is not the main ingredient in a solution: “Governments are not able to spend their way out of these challenges.”

• With diligent attention to the fiscal bottom line, states are attempting to create incentives for the market to pull some weight in the social arena…

1. Public-private partnerships to improve delivery of health and educational services are springing up throughout the region.

2. Decentralization of social services allows for more local ownership of projects.

3. Local governments are partnering with business in communities that have a vested interest in the development of a better-educated, healthier workforces and cleaner work environments.

• Still, the market is no substitute for good government policies in the context of efficient rules, regulations and laws enforced by an objective judicial system.

Stages of Adjustment…

• Development is a process of meeting the basic human needs of the population while enhancing options of how economic resources will be allocated today and in the future to increase the choices citizens have in their daily lives.

• In investigating the issues of stabilization, adjustment and growth we can identify three contemporary stages that countries pass through on the development journey…

1. Severe stabilization measures designed to bring macrofundamentals in line (after a debt crisis)…”triliemma” very relevant during this period.

2. Structural transformation: economy changes with respect to the relative balance of internal and external orientation as well as the roles of the state and the market.

3. Capacity building: focus on widespread enhancement of human capital, improving productivity and promoting the sound use of natural resources (including land). Top down vs. bottom up (NGOs). Institutional change (rules).

• All countries in Latin America have been working on stage 2 since the 1980s, have more to do, and have only recently begun paying attention to stage 3.

• Structural transformation without attention to capacity building is a recipe for political instability and economic stagnation. UN Millennium goals by 2015.

Final issues…

• The IMF needs to become more than an institution of last resort… this process has begun but there is much more that needs to be done.

• Ruling elites are being challenged as governments turn attention to the marginalized masses who posse the power to derail sustainable development efforts and the move to democracy (e.g. Venezuela).

• Still, if policy does not include those most needy of government attention to raise living, health, and education standards to a level consistent with human dignity and opportunity, the prospects for long-run economic development diminishes.

- El Fin -

Economics of Latin America & the Caribbean. LISTING OF LATIN AMERICAN COUNTRIES Argentina Belize...

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Transcript of Economics of Latin America & the Caribbean. LISTING OF LATIN AMERICAN COUNTRIES Argentina Belize...