Palestra no Foresight, Washington, DC, 18/06/2009
Known in the nineteen eighties as the Continent of crises, Latin America is now in a unique position, reminiscent in some ways of its fate during the Great Depression. In the same way as eighty years ago and in contrast to more recent episodes, it finds itself again as the victim, not the perpetrator of economic downfall. Another similarity with the thirties is that everything seems to indicate that, once more, it will recover faster than the central economies.
In the thirties, practically all Latin American countries, except Chile and Cuba, had surpassed their pre depression peak of real GDP many years before the USA: Colombia in 1932, Brazil in 1933, Mexico in 1934, and Argentina in 1935.[i]
The basic explanation for this relatively less severe crisis impact in Latin America and Asia can be found in an almost disregarded but essential fact: the channel of contagion. The central economies’ financial meltdown spread to so-called emerging economies not through its original causes but through its effects. The same causes as in the US – real estate bubbles, packages of securitized subprime mortgages, excessive financial deregulation, and dangerous levels of leverage – produced the same catastrophic results wherever they were present, in the United Kingdom, Ireland, Spain, or Iceland.
In Brazil, in Latin America as well as in Asia, contagion came rather through the byproducts of the crisis, mainly the abrupt finance and trade contraction. There were no major banks collapses, no bank runs, no real estate bubbles nor subprime worries. The only grave exceptions were the derivative losses in Mexico -$4 billion in the last quarter of 2008 - and in Brazil - estimated at $25 billion.[ii]
As a result, the Latin American financial and banking system remained basically intact notwithstanding a steep reduction in credit supply to productive activities, as a consequence of the loss of foreign credit lines. Nevertheless, some of the painful aspects of the economic slowdown could have been avoided were it not for some misjudgments about the crisis’ nature. Such mistakes were composed by the lack of capacity to conduct a vigorous and prompt countercyclical policy in economies that did not prepare adequately for the predictable downturn in external conditions.
Indeed, one of the lessons to be learnt from the management of the crisis in the region is the need to shed new light on an old truth: the clarity, intensity and speed of policy responses are as indispensable as the correctness of such policies’ general direction. The “best case” example of policies with all the desirable qualities has been Chile, where at one point the Central Bank resolutely cut the interest rate in a single stroke by astounding 250 basic points. More recently, in the 3rd week of June, it has again cut 50 points, easing the basic interest rate to 0.75 per cent, a level where it is expected to remain for the rest of the year.
At the same time, thanks to the clear-sightedness and prudence of building up a countercyclical fund, Chile and Peru were able to support the declining economy with a robust stimulus fiscal package in the amount of two per cent of GDP or more, thus contributing to soften the weakening in industrial production and in investment. It should be noted that both Chile and Peru faced greater vulnerabilities in the international crisis than Brazil because their export-to-GDP ratios are three to four times higher than the Brazilian coefficient, increasing the negative effect of world trade’s slowdown on the domestic economy.
The time when national authorities should have sent a resolute and unequivocal signal to the markets was at the height of the panic created by the mid-September 2008 Lehman Brothers collapse. In that crucial moment there was no longer any justification for mistargetting inflation, not recession, as the clear and present danger to the economy. Wherever authorities failed to respond in an appropriate way, the consequence has been to delay or slow economic recovery, creating unnecessary pain and suffering in terms of lost output and growing unemployment.
The record in crisis management has been somewhat mixed in some nations. In my own country, Brazil, the first signs of a consumer-driven recovery begin to appear. It is largely the product of a considerable expansion in current governmental expenditure with personnel and with a variety of social assistance programs, as well as tax cuts on cars and domestic appliances sales. It will probably help stimulate the consumption sector for the time being. However, the sustainability of the current rate of expenditure growth without additional tax raises will depend on a vigorous resumption of productive investment and industrial expansion.
Certainly, positive things could be mentioned about the post-Lehman Brothers economic policy measures in Brazil: reduction of compulsory deposit requirements held at Central Bank (took at the very beginning), guarantees to term bank deposits (valid, albeit a bit late), increasing lending by BNDES (National Development Bank), which has been operating with agility and substance in restructuring companies affected by the crisis.
All the same, there is no denying the evidences: at the critical moment in September-October 2008, monetary policy failed to provide entrepreneurs and markets with a stimulus sufficiently strong and timely to avoid a steep fall in industrial output and investment. The Brazilian real interest rate, the world’s highest, only started to be reduced, and very slightly, three months after September 15th. Despite further cuts later on, Brazilian interest rates remain the highest worldwide, leading to unnecessary and excessive reevaluation of the exchange rate. This process is ongoing since January 2009 and threatens Brazil’s position as one of the countries that will come out of this crisis most successfully. In addition, public investment in badly needed infrastructure did not reach the critical mass necessary in order to offset the deep plunge in private investment.
Under a few defining and important common characteristics, Latin America presents a huge diversity in conditions and intensity of crisis impact that should warn us against any attempt at simplifying reality.
Some smaller economies, mostly in Central America and the Caribbean, are acutely dependent on tourism or migrants’ remittances and have been particularly hit by the slowdown. Others, such as dollarized economies and countries that concentrate a high percentage of trade inside the North American Economic Space, closely mirror US’ vicissitudes and will probably have to wait for a change in United States’ fortunes. Finally, those who mainly export products derived from natural resources have been somewhat fortunate in finding in China a resilient source of demand for their commodities.
The reason why I am speaking about developments in Brazil and South America instead of repeating what you already abundantly know as far as the US and world financial troubles are concerned is because I want to stress a central fact regarding crisis management. Regardless of apportioning blame for the original roots of the crisis – and in this case it should squarely lay on the shoulders of American bankers, regulators and policymakers – the ultimate responsibility for passively accepting crisis fallouts in other nations or effectively neutralizing them depends on the quality and adequacy of national policy responses. In other words, the quality of national policies does matter.
This brings me to what we should expect from US government strategies. The first conclusion to be drawn from the crisis is the need to preserve national policy space. That is, countries should be free to adopt development policies according to their own specificities and interests.
In the recent past, financial sectors in industrial countries frequently pushed their governments to impose on developing nations premature and dangerous concessions of financial liberalization that were mainly in the narrow interest of the same people that brought about the current crisis. Too often this international dimension of Wall Street greed was a precondition of free trade agreements. It is regrettable that many international organizations and official banks took a very active part in this misguided attempt at promoting a wrong concept of globalization. It is by no means a coincidence that the two nations that were better able to resist the pressure, namely China and India, are the two economies least affected by a financial meltdown that virtually destroyed the likes of Iceland and others who eagerly embarked in the financial delusion.
We should further expect that the US government keep its commitment to a vigorous stimulus fiscal package as long as it is necessary for a consolidation of economic recovery without premature and unjustified fears of a return to inflation. We acknowledge the important contribution received by Mexico and Brazil from the US Federal Reserve last year under the form of a currency swap line of $30 billion for each country and we hope that the new Administration show its willingness of preserving and expanding similar initiatives for Latin America in case it proves fitting and sensible.
We rejoice in President Obama`s determination to give central priority to job creation and to revert the dangerous increase in inequality over decades of market fundamentalism. I also praise his attempt at linking the economic recovery to the pressing priority of fighting global warming and developing clean and renewable sources of energy. At the same time we hope that the new Administration will not implement protectionist measures such as the Buy American provision. Above all we expect that the US will recover its lost leadership in multilateral trade negotiations by abandoning its current dependence on huge agricultural subsidies, thus removing one of the major obstacles to a fair and balanced conclusion of the Doha Round of negotiations of the World Trade Organization.
Finally, a few words on the future role of the G20. It may not be the ideal and definitive formula for the governance of a globalized world. It should neither be seen as a substitute for a reformed Security Council nor as a kind of universal panacea for solving all international problems. It is, nevertheless, a practical and reasonably representative arrangement for tackling challenges where size and weight do matter. This is the case not only with a more effective and fair financial and economic order as well as with trade negotiations and climate change.
In order to fulfill this potential, however, the G20 has to deliver on the ambitious promises made in London regarding financial regulation and supervision, particularly in bringing about full transparency and openness in derivative and other markets created by financial innovation. The US government is setting the example by putting forward a comprehensive plan to overhaul and update financial regulation and supervision. But as Mr. Timothy Geithner and Mr. Lawrence Summers have stated in a press article, national actions will have little effect if they are not matched by similar international standards. Consequently they have promised that the US will lead the effort to improve regulation and supervision around the world.
This urgently requires a renewed effort by the G20 members to fulfill its pledge to produce a meaningful reform of the financial sector in order to place it at the service of promoting production and wellbeing, rather than to serve as a de-stabilizing force in the international economy or as an end in itself. The task should be given pressing priority or we run the risk of wasting the crisis by allowing that the reform effort falters as people become relaxed and deluded by premature signs of a superficial recovery.
First and foremost, the G20 has to keep its word and meet the solemn committment to introduce a more balanced representation in the governance of the IMF, the World Bank and other key economic multilateral institutions, giving voice and vote to developing countries long marginalized in decision-making. The reform of the Bretton Woods institutions will be seen as a litmus test of the sincerity and fairness of advanced industrial economies as it will necessarily entail a redistribution of power and influence from overrepresented nations, mainly from Europe, towards entire continents such as Asia, Latin America and Africa, which are extremely underrepresented under the current rules.
In practical and immediate terms, it is imperative that the IMF effectively receives the expanded resources to support those in need of special help. This goes beyond the newly established Flexible Credit Line (FCL) facility whose usefulness has already been demonstrated by the credit lines of $47 billion extended to Mexico and the $10, 5 billion to Colombia. It is equally necessary that the more vulnerable members of the international community who do not presently qualify for the FCL will not be left without adequate assistance.
I wish to conclude by leaving here a concrete suggestion on a topic that is not at the core of this seminar, but is nonetheless acknowledged by everyone as central in the shaping of a new world order. It is known that no more than fifteen countries, considering the European Union as a single entity, are responsible for about 80% of all gas emissions that are at the root of global warming. All of them are G20 members.
A decisive contribution towards making the G20 an indispensable part of the new international order would be to use it as the negotiating forum of a successful compromise among all leading world economies, a compromise that deserved to be endorsed at the Copenhagen Conference on Climate Change in December of this current year. After having served as the meeting point of different but converging perspectives on the present and immediate danger of the financial crisis, why not try and prove its usefulness in tackling the most serious threat to human civilization in the years ahead?
Finally, I have been requested to provide a synthesis of the new growth dynamic of the world economy. The relative position of emerging market economies – vis-à-vis the world market – will be strengthened. A number of reasons account for the rebalance: (i) growth differentials; (ii) current account imbalances and (iii) domestic debt differentials Global recovery will be led by emerging markets, especially the large economies in Asia and Latin America with sizeable domestic markets. Prior to Lehman emerging market economies displayed solid growth in spite of the decline in growth of mature economies. The Lehman event proved to be a landmark as it precipitated a global scramble for liquidity. Emerging market economies were heavily affected by this major liquidity event. Once liquidity conditions in the whole world normalize, however, one should expect the resumption of the growth differentials that prevailed before the Lehman shock.
Overall growth in the whole world will be subdue for a long period of time but growth differentials will be more pronounced than before. True, the emerging markets economies cannot be described as a single bloc. In Latin America, we have countries following unsustainable economic policies like Venezuela. In Eastern Europe there are countries in which the adverse linkage between exchange rate devaluations and banking magnified the impact of the Lehman liquidity squeeze, provoking sharp declines in economic activity. In Asia, some export-led economies like Korea faced difficulties in replacing external demand by domestic demand. But overall it may be said that growth in the emerging market economies will be in 2009 and 2010 above growth in mature economies.
If one considers the bloc of emerging market economies against mature economies, the current account balance was roughly in equilibrium (close to zero) up to 1998. From 1998 onwards emerging market economies exhibited a current account surplus. The current crisis decreased somewhat the surplus (from USD 438 billion in 2007 to approximately USD 300 billion in 2009 in IIF estimates) but the imbalance will in all likelihood increase again in 2010. The argument that the so-called Breton Woods II informal agreement would fade away proved to be ungrounded. Emerging market economies will continue to be creditor economies.
The widespread adoption of anti-cyclical fiscal policies will lead to higher debt to GDP ratios in the entire world. But the impact will be more dramatic in G7 economies. The net debt of US and UK, for instance, will raise to 70% of GDP by end of 2010 (official estimates), a near doubling of pre-crisis levels, while some mature economies may experience even larger numbers. As a consequence, market perceptions of relative risk will change in favour of emerging markets, at least in those where governments know how to put in practice sound economic policies.
In this context, one should expect a rebalance of power within multilateral institutions like IMF; real emerging markets currency appreciation relative to mature economies; and growing trade between emerging market economies, leading in some cases to the denomination of trade agreements in emerging market currencies. In the same way one should expect an increase in finance and investment flows between emerging private companies, dispensing with the intermediation of mature economies financial institutions.
What countries among emerging economies will fare better, and what countries among mature economies will perform least poorly? The answer depends on objective circumstances, namely how they interact with the global economy and above all, how successful they take advantage of their own national space to take decisive economic policies to promote their development according to their own specificities and interests.
[i] See Victor Bulmer-Thomas, The Economic History of Latin America Since Independence, second edition, Cambridge University Press, 2003, p. 225
[ii] See article “The Global Crisis and Latin America: Financial Impact and Policy Responses”, by Jara, Moreno, and Tovar, BIS Quarterly Review, June 2009, Box 1, p. 55.