LATIN AMERICA: IS IT MOVING FORWARD

1
LATIN AMERICA IS IT MOVING FORWARD?

• Ricardo Hausmann
• Kennedy School of Government
• Harvard University

2
Outline

• Structural reform and growth
• Demographic window of opportunity
• Financial Turmoil and contagion
• Original sin an interpretation of the problem
• The boom in FDI what does it mean?
• The recovery in Latin America
• Prospects for long-run growth

3
Latin America recovered in the 1990s
GDP Growth
6
5
4
3
porcentaje
2
1
0
1965-70
1971-80
1981-90
1991-98
Fuente IDB
4
Based on significant structural reform
Avance de las políticas estructurales
80
Trade
60
Financial
40
Variación relativo al máximo
20
0
Fuente Lora, 1997
5
that is still incomplete by area
Avance de las políticas estructurales
80
Trade
60
Financial
40
Tax
Variación relativo al máximo
Privatization
20
Labor
0
Fuente Lora, 1997
6

More reforms, more growth
Cambios en Crecimiento y en
Políticas Estructurales (1993-95 vs. 1987-89)
15
Perú
10
Nicaragua
Cambios en Tasas de Crecimiento
Argentina
5
El Salvador
Trinidad and Tobago
Brazil
Ecuador
Bolivia
Colombia
Guatemala
Costa Rica
0
Uruguay
Venezuela
Paraguay
República Dominicana
Chile
Honduras
Mexico
Jamaica
-5
0
5
10
15
20
25
30
35
40
Cambios en Indices de Política
Fuente Lora y Barrera, 1997
7
1997 was a very good year
Real GDP Growth (Average 8 Largest Economies)
percent
8
but then came a bad streak

• Asian Financial crisis
• Collapse in the terms of trade
• El Niño
• Russian crisis and contagion
• Hurricanes Georges and Mitch
• Brazilian crisis

9
The collapse in the terms of trade
Commodity Prices
125
115
Copper
105
95
Wheat
85
75
Oil
65
55
45
Hong Kong
Russia
Thailand
35
1/2/97
2/2/97
3/2/97
4/2/97
5/2/97
6/2/97
7/2/97
8/2/97
9/2/97
1/2/98
2/2/98
3/2/98
4/2/98
5/2/98
6/2/98
7/2/98
8/2/98
9/2/98
1/2/99
10/2/97
11/2/97
12/2/97
10/2/98
11/2/98
12/2/98
Index 01/02/97 100
10
Major financial shocks and recovery
Latin Eurobond Index Spread (1994-98)
11
Private capital inflows collapsed
Net Capital Inflows and Commodity Prices
100
130
95
125
90
120
85
80
115
Non-fuel commodity prices
75
Capital Flows
110
70
105
65
60
100
55
95
50
90
45
40
85
1991
1992
1993
1994
1995
1996
1997
1998
1999
12
when they were most needed
Net Capital Inflows and Commodity Prices
100
130
95
125
90
120
85
80
115
Non-fuel commodity prices
75
Capital Flows
110
70
105
65
60
100
55
95
50
90
45
40
85
1991
1992
1993
1994
1995
1996
1997
1998
1999
13
only marginally offset by official financing ...
90
80
70
60
50
40
30
20
10
0
-10
-20
1997
1998
1999
Private Net Flows
Official Inflows
Acum of Reserves
CAD
14
causing a collapse in imports
Trade and Current Account
(excl. Mexico)
160
140
120
100
80
60
40
20
0.
1991
1992
1993
1994
1995
1996
1997
1998
1999
-20
-40
-60
-80
Exports(-Mex)
Imports(-Mex)
Trade Balance(-Mex)
CA(-Mex)
15
that exceeded the fall in exports
Comparing Recessions (absolute change between
periods)
35
Imports
25
Exports
15
Trade Balance
5
-5
-15
-25
-35
1994-1995
1997-1999
Source WEO
16
and caused a collapse in growth
Real Growth in Latin America
6
5
4
3
2
1
0
1991
1992
1993
1994
1995
1996
1997
1998
1999
Source WEO
17
that affected most countries
Fall in Growth (Average 1999-98 vs 1997)
Venezuela
Argentina
Ecuador
Chile
Guyana
Peru
Western Hemisphere
Uruguay
Mexico
Brazil
Colombia
Suriname
El Salvador
Dominican Rep.
Belize
Bahamas
Panama
Grenada
Honduras
Paraguay
TrinidadTob
Guatemala
Dominica
Nicaragua
Bolivia
Barbados
Haiti
Jamaica
Costa Rica
18
Latin America no Fireworks

• Since the East Asian crisis
• No systemic banking crises
• No widespread currency crises
• No inflationary crises
• No debt crisis
• No reversal of reforms

19
Exceptions

• Ecuador is a real exception
• Brazil not really an exception, just a currency
  realignment that has not generated any other
  symptom
• Colombia? Venezuela?

20
Capital flows have been recovering
4.0
Figure 12a Net Private Capital Inflows,
Portfolio, FDI and Loans in Latin America,
1996-2000
3.5
Private Capital Inflows
3.0
2.5
2.0
FDI
1.5
Portfolio
1.0
0.5
Loans
0.0
1996
1997
1998
1999
2000
-0.5
-1.0
Note As percentage of GDP.
Source Balance of Payments, IMF.
21
Commodity prices have stopped falling
Commodity Indexes
(Index Jan 97100)
120
110
100
Agricultural
90
80
70
60
50
Energy
40
30
01/01/97
01/31/97
03/04/97
04/03/97
05/05/97
06/04/97
07/04/97
08/05/97
09/04/97
10/06/97
11/05/97
12/05/97
01/06/98
02/05/98
03/09/98
04/08/98
05/08/98
06/09/98
07/09/98
08/10/98
09/09/98
10/09/98
11/10/98
12/10/98
01/11/99
02/10/99
03/12/99
04/13/99
05/13/99
06/14/99
07/14/99
08/13/99
09/14/99
10/14/99
11/15/99
12/15/99
01/14/00
02/15/00
03/16/00
04/17/00
05/17/00
Source Goldman Sahcs Commodity Indexes
22
World outlook looks good

• Continued recovery in Europe
• and in East Asia
• mild recovery in Japan
• and a roaring US economy

23
and the region is expected to recover
Real Growth in Latin America
Annual percent change
6
5
4

3
2
1
0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Source WEO
24
What will the future bring?

• Are we facing another boom?
• Will it be followed by another crisis?
• or will it be sustained?

25
Four scenarios ahead
Dangerous
Safe
High, sustained flows
Boom - Crisis
Deep
Mild boom- crisis
No boom- no crisis
Shalow
26
The origin of crises the mainstream approach

• Booms and crises were caused by moral hazard
• and an inadequate perception of risks

27
Mainstream View 1 Shallow and safe

• Large recent losses
• and changes to international financial
  architecture
• lower bail-outs, more bail-ins
• more flexible exchange rates
• will reduce moral hazard, giving rise to a more
  moderate but sustainable scenario.

28
Mainstream View 2 Deep and
dangerous

• Booms and crises are caused by moral hazard
• ...but nothing substantial has changed
• so we will get another boom, followed by another
  crisis

29
The origin of crises the
mismatch approach

• Crises are not caused by moral hazard.
• They are caused by mismatches which leave
  countries vulnerable to self-fulfilling attacks.
• ORIGINAL SIN unable to borrow internationally in
  own currency
• Changes in architecture have made things worse
• The mismatches are in the stocks, not in the
  flows.

30
Original sin World Comparison
Debt in Currency X Over Debt in Country X, 1998
(Money Market Instruments and Bonds)
United States
Luxembourg
Switzerland
Japan
Italy
South Africa
New Zealand
United Kingdom
Germany
France
Portugal
Hong Kong
Netherlands
Australia
Denmark
Poland
Spain
Canada
Greece
Taiwan
Belgium
Ireland
Sweden
Finland
Cyprus
Norway
Austria
Singapore
Argentina
Indonesia
Thailand
Mexico
Malaysia
0
0.5
1
1.5
2
2.5
Source BIS
31
View 3Shallow and dangerous

• Countries do not deal with the mismatches
• Risks are perceived as high,
• Flows will be low
• ...but still a crisis.
• Deep and dangerous also a possibility if the
  market focuses on the good equilibrium

32
View 4Deep and Safe

• Countries deal with the mismatches
• developing the ability to borrow internationally
  in their own currency
• adopting common currency that does not have
  original sin.
• The market can support large, sustainable flows

33
FDI has been booming
FDI Flows 1990-1999
80000
70000
60000
50000
Millions US
40000
New FDI
30000
MA,privatization
20000
10000
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999a
Source ECLAC
34
but in the context of declining total flows
Net Commercial Capital Flows and Its Composition
for Latin America
120
1.2
FDI / Total Flows ()
100
1
Net Commercial Flows
80
0.8
US Billions
Percentage
60
0.6
FDI
40
0.4
20
0.2
0
0
1996
1997
1998
1999
Source IIF
35
Is FDI like good cholesterol?
36
Conventional wisdom

• Capital is like cholesterol
• Good cholesterol FDI
• Brings technology, market access, managerial
  skills
• It is bolted down
• It is attracted by long-term prospects and good
  institutions

37
Conventional wisdom

• Bad cholesterol Hot portfolio money
• Driven by short-term speculative considerations
• Affected by moral hazard
• First to flee

38
More development, more foreign capital
Foreign Capital Stock and Income
60
Developed
50
40
30
Foreign Capital Stock / GDP
LATIN AMERICA
20
East Asia
East Europe
10
Asia
Africa
0
-10
2.5
3.0
3.5
4.0
4.5
GDP per capita (log)
Data refers to stocks of 1997 in current dollars
and GDP in PPP current dollars. The GDP per
capita is a weighted average of countries for the
same year.
Source IFS, WB and RES-IDB.
39
but a smaller FDI share
Composition of Foreign Capital Stock and Income
100
Africa
80
60
Asia
FDI / Total Capital Flows
East Asia
40
LATIN AMERICA
East Europe
Developed
20
0
2.5
3.0
3.5
4.0
4.5
GDP per capita (log)
Data refers to stocks of 1997 in current dollars
and GDP in PPP current dollars. The GDP per
capita is a weighted average of countries for the
same year.
Source IFS, WB and RES-IDB.
40
FDI/GDP Outcome of opposite forces
FDI Stock and Income
8
LATIN AMERICA
Developed
7
East Asia
6
FDI/GDP
5
East Europe
4
Africa
Asia
3
2
2.5
3.0
3.5
4.0
4.5
GDP per capita (log)
Data refers to stocks of 1997 in current dollars
and GDP in PPP current dollars. The GDP per
capita is a weighted average of countries for the
same year.
Source IFS, WB and RES-IDB.
41
Richer, larger, more open economies dont have
higher FDI-shares
Correlations with Volume and Composition of
Capital Flows
0.8
Volume
0.6
0.4
FDI/GDP
0.2
0.0
-0.2
-0.4
Composition
-0.6
Income
Size
Openness
42
Riskier countries get less capital, but a larger
share of FDI
Correlations with Volume and Composition of
Capital Flows
0.6
Composition
0.4
0.2
FDI/GDP
0.0
Volume
-0.2
-0.4
-0.6
Country Risk
43
Resource rich, distant countries dont get more
capital, but higher FDI-share
Correlations with Volume and Composition of
Capital Flows
0.6
Composition
0.4
0.2
FDI/GDP
0.0
-0.2
Volume
-0.4
-0.6
Subsoil Resources
Distance
44
Better finance, better institutions dont beget
more FDI-share
Correlations with Volume and Composition of
Capital Flows
0.8
Volume
0.6
FDI/GDP
0.4
0.2
0.0
-0.2
-0.4
Composition
-0.6
Financial Development
Quality of Institutions
45
Original sin increases FDI-share
Correlations with Volume and Composition of
Capital Flows
Composition
0.4
0.2
FDI/GDP
Volume
0.0
-0.2
-0.4
Original Sin
46
Good things are associated with more foreign
capital inflows but a lower share of FDI

• Controlling for income, size and openness, lower
  risk and better institutions do not increase the
  share of FDI

47
Hypothesis

• FDI is booming because firms are redefining their
  shape so as to circumvent lousy debt markets
• FDI is a solution to the mismatch problem caused
  by original sin
• Long term and no currency denomination
• FDI may also limit liquidity problems
• Implications for optimal financial structures
• IPOs to domestic market or MA to a strategic
  investor?

48
Looking into the more distant future
49
Structural reforms are continuing
Bank Supervision
Pensions Funds
Capital Market
Privatiz. Regulations
Comercial(X,M)
Foreign Investment
Education
Tax Sistem
Justice
Labor
Property Rights
Health
0
0.2
0.4
0.6
0.8
1
1.2
Source Survey. Note Difference with respect to
3 years ago (based on scale 0-5)
50
Latin America has a Demographic Window of
Opportunity
Adjusted dependency ratio
1.6
1.5
1.4
1.3
1.2
Window of opportunity
Adjusted dependency ratio
1.1
1.0
0.9
0.8
0.7
1950
1960
1970
1980
1990
2000
2010
2020
2030
2040
2050
Source Duryea and Székely (1998)
51
What does demographic opportunity imply?

• More work
• More savings
• More education
• THE OPPORTUNITY TO BE THE FASTEST GROWING REGION
  IN THE WORLD