I ~~~-A~~~ ISW~ .40~ ~ ~ ~~~~~~~~~~s4 V7 41~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~- J1, ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~9 -e- V1, 1,0~~~~~~~~~~~~~~- a-- ~ ~ A, i- - WORLD BANK LATIN AMERICAN AND CARIBBEAN STUDIES Piepoints Latin America after Mexico Quickening the Pace Slahiid Javed Burki Sebastian Edwards The IYorld Bank Uaishington, D. C. Copyright ©) 1996 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing June 1996 The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. 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The complete backlist of publications from the World Bank is shown in the annual Index of Puiblicationis, which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'lena, 75116 Paris, France. The painting on the cover is Recontre, by Pedro Coronel, reproduced courtesy of Christie's. Shahid Javed Burki is vice president for the Latin America and Caribbean regional office of the World Bank. Sebastian Edwards was chief economist in that office when this paper was written. Library of Congress Cataloging-in-Publication Data Burki, Shahid Javed. Latin America after Mexico: quickening the pace / Shahid Javed Burki and Sebastian Edwards. p. cm. - (World Bank Latin American and Caribbean study) Includes bibliographical references. ISBN 0-8213-3629-0 1. Latin America-Economic conditions-1982- 2. Mexico-Economic conditions-1994- 3. Latin America-Economic policy. 4. Mexico- Economic policy-1994- I. Edwards, Sebastian, 1953- II. Series: World Bank Latin American and Caribbean studies. HC125.B768 1996 338.98-dc20 96-22783 CIP iii CONTENTS I. INTRODUCTION ............................................................ I II. THE MEXICAN CRISIS AND SHORT-TERM CONTAGION EFFECTS ............................................................ 3 A. WlIv Did the Mexico Crisis Happen;' ............................................................ 3 B. Mexico.s Policv 1 sX'bgL'. il 'ii imenit" of the Mexicani econlomyi dUnrig' 1 994- Coun11trieS hadl begLvn to look at their econiomiic the acute overvaluation Of the CLirreiicy rapid per-formianice anid prospects onily a few, mioniths credit expansoion and the piling uIP of short-term agyohas g,iVenl wa'V to a SenISe Of Lirge ncN~ debt-provided ani inidicationl that the LAG Evenits in Mexico also miade it clear to the counitries were niot vet readv for- the rigors of a remoion's leaders that reformi is a coritinuinCr market-based svstemi. Othiers polinted ouit that pr-ocess whilch niever stops anid that they nuiist be disappolintmient anid nostalgia couild brinig back permianientlv alert to changes in the environmen popuilismi, statismi anid control. Inl whilch theyv operate. The global econiomyi of These reactionis have proved g-roundless. In thec late ?()th cenitury is a bit like Alc,Tbrori(li fact, the Mexicancisi ha-SS 1S tuirned ouit to he a tlic, Lookiu,, Class. It takes all the running you 2 L \ T I N A N1 E K I I A A i IL 1R M L X I - () canl do to keep in the samze place. It you vwant to need to take rapid action, it induced the imlple- go somiiewlhere else, you miiust ruLn at least twice nientation of policies with utnavoidable short- as fast. Leaders fromii a gr-owin1g number of COUnI- terml recessionary effects. Although these policy tries in the region have conlcluded that deepeni- decisions m1ade the first quarter of 1995 difficult ing reformls-and doinig so imiore rapidly-is the for soini couLntries in the region, long-term only way to couLnter the skepticismii that emilerged growth prospects have been enhlanLced. amiong interniationial finiancial analysts and, miore D)eepening the reformii process is the surest route importantly, to miiove firmiily toward prosperity to accelerating- the regioni's average rate of and social hlarnilonyt growtlh in the Iniediuimi and longer run: we The Mexican crisis crystallized the urgenrcy expect that if a set of plausible conditionis is met, of mlloving to a second phase in the reform the regioni will grow, on average, at rates in process and clarified its agenida. Rebltilditng the excess of 6 percent per annlluml betweeni 1998 state and reducing poverty and inequalities are and 2005. critical for the conisolidationi of the reforms that This report introduces a new annual publi- have already been advaniced as well as for fuLture cationi by the Latin American and Caribbean growthl. Reg,ion of the World Bank. Each year the Vice More specifically, Mexican events turnied President and the Chief Econiomiiist will present a cautioln lights on a nuiLnber of the regioni's prob- review and alnalysis of somoe of the imiost impor- leimis. Raising domlestic savings rates, encouragilng tant developmiients in LAC during the preceding private linvestiiieit in infi-astructure, reforiniing the 12 months. This year's report places particular labor codes and educationi systemis, and deregulat- emiiphasis on the Mexican peso crisis, its imiipact ing and de-bureaucratizing lower levels of gov- and the challenges that lie ahead. Section 11 con1- erminiient now top the list of reform-l priorities. tains a detailed discussioni of the causes of the More importantly, a growing numLiber of' Mexicani crisis, of the March 9 adjustment pro- leaders in the regioni see the pressing need to grami, and of the likely effects of this episode on rebuild the state. New institLtionis imiust be created somiie of the largest countries in the region. to performii efficieltly those tasks that the private Section III presents an analysis of the maill eco- sector canniot undertake-the maintenance of law nlomlic and institutionial challeniges for LAC in and order, the provision of basic social services to the years ahead. Sectioni IV discusses mediulll- the poor, the establishment of mioderin, indepeni- and long-termi g-rowthl prospects. Section V pro- dent, professional regulatory bodies, and the provi- vides the conclusionis. In addition, recent eco- slon of basic infr-astructure, amiong others. inoniic developmilenlts in the region are presented Because the Mexican crisis drove homiie the in an appendix. 3 THE MEXICAN CRISIS AND SHORT-TERM CONTAGION EFFECTS RECENT EVENTS IN MEXICO raised qcuestionis regarding, the sustainability of the market-orienited reforim process in LAC. As we will argue, a detailed review of the Mexicani episode reveals that the reforml process is indeed sustainable, even mlore so IIoW that the crisis prodLiced a loud and clear mlessage throughouLt the regioni in favor of str-enlgtheninlg and deepeniing existing policies, and stepping tIp the effort to improve social coniditions. A. W H Y D ID THE ME XI CA N imarked decrease in Mexican private savings dur- CRISIS HAPPEN? inig recent years. Before the Decemuber crisis, mlost analysts of The imiaini reason fotr the Mexicani peso cri- the Mexicani situationi acknowledged the need to sis was ani u,srtistabiabh' curroir accomit dhicit, finianiced by large capital inflows.' Hlow did the Figure 1: currenit accounit deficit get to this level? This \vas Private Domestic Savings partially the result of Mexico's "suLccess," partially In Mexico, 1989-94 the result of political developments, and partiallly r__ the consequeince of over conifidenice. As reformiis were unldertakeni and inflation declined in the early 199( )s, the world financial coInununIity \ wanited to take part in the rebirth of Mexico's economy. It did so by imlovinlg futnds-miiostly short runl, portfolio capital-inito the couLntryt This was furtlher facilitated ly the declinie in U.S. r._-_ interest rates durinig 1993.The inflow of capital '- helped finanice a tremiienidous private sector coIn- ° 121 P12 r' 1'- suimiption boom1 anid, in 1994, ani expansion in ll public sector expeniditures. Flgure 1 shovs the SULL 9 Ae i r . B 4 L \ I I N A M F I I ( .A A iP I F I M rxc X ( (u im1plemiien]t somae type of adjustment. The qges- maintain its overall mzonietary program, steriliziiig tion was: when? Mexican policyvmakers favored the reductioll in interniationial reserves. During an eventual rather- thani an immlilediate response. 1993 and 1 994 the fiscal stance also became In Septemiber 1994, the World Bank argued in a somiiewhlat loose The overall fiscal balance deteri- public documaenit that thie excessive reliance on1 orated 2 percenit of GDP, wlile the primary bal- capital inflows had mzade Mexico vulnierable, cit- ance deteriorated by alnaost 3 percentage points in, the fall in savings rates and the link to higher of GDP. Furtlhermiiore, the tripartite agreenmenit consum11ptionI levels.3 The Bank also meniitionied witlh business and uniOlis-the so-called paicto- that "productivity growth has so far been insutfi- led the zovernmnent to rule out an early curreni- cient to offset the loss of external comiipetitive- cy depreciation to correct the accumiiulated over- ness im1plied by the peso appreciationl.' valuation. Wage increases had generally been set Mexicani authorities recognized that the above the rate of nominlal depreciation, an excess cur-renit account gap could notr be miiaintainied at that was n1ot compenisated by productivity gains. the 1993-94 level in the longer ruLn, and plannled After the presidential elections were woni by the to deal witlh the problemi gradually This view PRI candidate Ernesto Zedillo, the authorities was based on1 two key assum1ptionis: First, still resisted pUtting in place a contractioinary imlprovenwieiuts in productivity' would increase adjcustment programii. export competitiveiness, helpiig, close the trade The circumlistanices that led to the rapid gap; and second, the approval of NAFTA woould uLnr-aveling of Mexico's economiiy are IIow well entice additional capital to m1ove into Mexico, knowxn. When, unider pressure, the exchange rate providing space and timie for the gradual adjust- band \vas broadened on VDeceniber 2(1. it was imenit to work, too little too late. The interniationial financial A nullmber of developimients, however, frtis- colmlnulaity reacted in disbelief, and generated a trated this plan. First, political events in 1994 chain-reactioni financial panic. The announce- frighteined foreign investors, who became partic- mzeint by thie Clinton administration of the pro- ularly leery about currency risk.4 In ani effort to visionI of massive loan guarantees temiiporarily avoid rising peso interest rates, the Mexicani calmed the mwarkets in mid-Jalluiary. Soon, how- authorities issued increasilg am1ouLnts of peso ever, it became clear that the rescue package deniomiiniated but dollar indexed, short miaturity Would not be approved by thie U.S. Congress, notes-the infamous rtsb)1vons. Second, lhigher and the peso ca11ne unlder- renewed pressure. By interest rates in the United States during 1994 that tilme it was obvious that Mexico faced a fLrther reduced capital flows into Mexico. And nmajor crisis, and that it wxould require a mlajor third, altlhouglh productivity beglin to imlprove in adjustLSmen]t, includinig a drastic turn-iarounld in 1993-94, it was not enough to gei4erate the the currelnt accounit, high uLnleploymiienit and a expected boom1 in exports so as to compensate substantial decline in the level of economiiic for the increase in im1ports. activity. It xvas not unltil April, after the As a result of these factors. and in spite of annouLnceC11ellt of an1 extremely strict adjustment the rapid increase in outstandingss, tesobonios, capi- prograllml on1 March 9, that the financial markets tal inflows declined markedly durinig 1994. The began to settle. current accounlt deficit wias largely finanaced throutgh a reduction1 in inter-niationial reserves, B. MEXICO'S POLICY RESPONSE which dropped from1 approximately US$31) bil- lion in February 1 994 to US$5 billion by After the failure of early attempts at restor- December 22. With presidential elections loom- ing, mlar-ket confidenice, the Mexican gTovernm11enit inig, authorities ruled out immpleuielltinlgr contrac- finally tinveiled a tight nmacro program oin Marcl tionary credit and fiscal policies durin-g, the first 9, backed by a nimjor IMF standby agreemiienit half of 1994, and in spite of-the decline in inter- siglnied in Jaluary. Its main objective is the national liquiditv, the central bank decided to restoration of stabilitv and the rebluildilng of QL U I E K E \\ I N r H fE P A C E 5 interniationial confidence. The plan also calls for of piblic health insuranice for the uniemiiployed, aggressive moves on1 infrastructure privatization, the initiationi of a programl of public works tar- decentralization, reformls in the legal and judicial geted to the poorest of the unemployed and systeim and im1provemiient in the eftectiveness of the expansioni of the labor retrainingi program. social programns. The March 9 programn broke some new Here are the miiain elemlenits of the programii ground in Mexico's effort to stabilize and anniouniced Marclh 9: restructure its economiiy. Given the miagnitude of the adjustmenit effort that was called for, the * The fiscal mleasures include an adjustmiienit in adminlistration of President Erntesto Zedillo did prices of public sector goods, an increase of the not attemlpt to reach advance consenisus with value added tax from1 1D percent to 15 percent labor and the business community on) the inea- on most goods and a reduction in the real level sures adopted, as had been done since 1987. By of public expenditure. In 1995, tiglhter fiscal 'givilng up the pacrt) Presidenit Zedillo took UpoII policy is expected to produce a primary budget himllself the responsibility for engineering eco- surplus of 4.4 percent, twice as large as the one Inoiic chanige. Second, by abandoninlg the fixed originally envisionied in January 1995. exclanrge rate regimle. the admin1istrationi shifted the burdeni of adjustmlenit on1to fiscal discipline. * The authorities commiiitted themiiselves to a The fact that the exchange rate has stabi- floating exchange rate regimle, withi mlonietary lized anid that the stock mzarket has regainied part policy designed to help stabilize prices.To of the lost grounid indicates that the adjustm1enit achieve an inflation target of 42 percenit in program1 put in place is adequate. Despite the 1995, the Bank of Mexico would restrict the increase in inflationi, there has been a major cor- expanision of net domlestic assets to 23 percent. rection in the level of the real exchange rate, \vhich is producinig the IIImuChI needed adjustment * With the assistance of a im'jor World Bank in the trade balance. Once stabilization is coImI- operation, Mexico designed a programii to pletely established, growth will be restored on1 a strengtlheni the banking sector thlroughl intensive mluchi firmler basis. supervision and regulation. It increased capital requiremlenits and loan loss reserves, and C. SC) ME LESSONS remiioved the ceiling for foreigni ownierslhip of Mexican banks. A foreign currenicy line of The Mexican crisis offers-or, maore accu- credit was established to enable domnestic banks rately, reaffirmls-seven tundamiien-tal lessons to moeet their interniationial commiiitmiienits and regardinig the economic reform process: created a subordinated convertible debt pro- graini to help banks experiencinig a temiiporary UThe currenit account is a key variable that fall in their capital requirements. It gave should not get "out of line."The mlagnitude of FOBAPROA (Fondo Bancario de Proteccion the currenit accounlt deficit sustainiable in the al Ahorro) the righlt to convert the subordinat- mlediumi and long ruLs w ill depend on a IIUIII- ed debt of banks into capital and to take them1 ber of variables, including the demand for the over. country s securities and the rate of growth of GDP. Under mlost circumstanices, a sustainable * Notwithstanidinig the severe fiscal contractioni, deficit would rarely exceed 3 percent of GDP. real expeniditure for social and rural programls Since successful stabilization programls-and in 1995 is to incr-ease by 2 percent, wahile other especially those based on1 a fixed nominial non-initerest expenditure is expected to fall by exchange rate generate a private sector coII- almost 2(:) percent. An etfort is being miade to suLmlptioni boomi, mzainitainin1Łg the current fortify the social safety net throughl an expan- accoullt unider control xvill generally require slon of the negative inicomlle tax, an extensioni higher public sector savings. 6 L A r I N A M E R I C A A T F TR M E X I *The comlposition of capital inflows is very chianges in interniationial reserves. Maintaininig imlportanit. Short-terml flows are very sensitive this tvpe of policy is not easy politically, since to chaniges in interest rates and to political nonisterilized declines in reserves are translated events. Keeping speculative capital under coin- into high real interest rates, reduced economic trol, wlile encouraging long-terml invest- activity anid highi uniieuiplovinienit. ment-as Chile has done-miakes eininenit sense. Increasing the share of long-termii invest- U Particular- attentioni should be given not only to maenit funds. however, will not be easv. Investors the size but also to the terml structure and cur- are looking at the analyses of investient rating rency denomiinlation of public debt.The accu- agencies before committing large volumles of mLulationi of short-terml maturity debt is a signal fLinds. Until now only two LAC countries- of ulnderlying fiscal problemls and inconisistenit Chile and Colomnbia-have attained investment mlacroecononmic policies. grade ratings. Achievinig this status will require other counltries to pursue their reformii pro- U In redefininig the role of the state-as is being gramls vigoro usly. Also, the characteristics-and done both imuplicitly and explicitly in most of especially the strengtlheninig of the domiiestic Latin Amlerica and the Caribbeani-it is imlpor- finanicial svste-ii-wil determiinie the way in tant niot to forrget that a strong state is a prereq- which capital inflows are incermiiediated and uisite for a robust economy. The state should channiieled throughout the econionwiv. draw its strength not by Owninig induLstrial assets, manliaginig public institutions and con- * Productivity gains are a tfLndaimienital elemlenit in ducting comlmllerce. It should do so by building the economy. They are at the heart of export powerfiul institutions-legal systemls, regulatory expansioni and. thlls, contribute to keeping the agencies, and the like-that help promote coiml- currenit accoullt in balance. Productivity petition, protect the consuLmer, and provide a increases, in turin, depenid critically' UpOI the frameework \vithin wliclh the response of all amloullt of effort the governmiiient is prepared to econlloic agents can be predicted with reason- mlake in developing hutman resotirces and able accuracv. imlprovinig physical infrastructure. * Impir-oviing income distribution and alleviatinig * There is an inhlie-eret danger in uising fixed poverty cannlot be left to trickle downi conse- exchange rates as a stabilization device. quLences of econoillc growtlh. Governmiienit Experience has showxv that they tend to gener- policies-in particular fiscal programs and tax ate real exchange rate overvaluation and loss in adminlistrationi efficiency and fairness-are crit- external competitiveness.This is particularly the ical for improving the distribution of incomiie case in countries wher-e contracts are subject to and reducinig poverty;As Mexico is discovering, somle inertia. Moreover, fixed nomiuinial stabilization prograins have a better chanice of exchange rates tend to distract policyinakers succeedinig if political peace can be secured and the public froml the need( to imiiplemlenit witlh the help of social safety nets. policies to put in place-and, as imlportanit. to maintain-a fiscal anchor. Fixed exchange rates D. CONTAGION EFFECTS are particularly difficult to preserve in situationis of high capital mobility If, however, a couLntry In spite of the fact that the Mexican crisis is decides to adopt an exchange-rate based stabi- producinig policy reactions that will bear fruit in lization program, it is essential that the authori- the long run, it has generated short-terml turbu- ties imlplemiient the policies that assure the fixed lenice in the region. Latin America and the parity will be mnaintained. This mleanis that the Caribbean is a highly diverse regioni, where fiscal situationi has to be unlder- control and that couLntries face very different conditionis, and the mlonietary authorities do Inot sterilize where different econoIflies have different Q u1 I ( K 1- \ I N \ T I IE P A ( U * 7 strengtlhs and weaknesses. For this reasoni ajiv Convertibility Law in an increasinigly dollarized serious analysis of the inmpact of the crisis should, econiomiiy could add to econoiic instability. The ultimiately, focus on individual counltries. Having onily internial response to the recent test of the already discussed the situation in Mexico, we program x was fiscal tighteninig and the further now proceed to analyze the econollmic circumii- stren,gtlheninig of the adjustment process. In a dis- stanices in five of the large counitries of the play of vision and with the exercise Of stronlg region, three of which-Argentina, Brazil anid leadership, the governmllenit reacted forcefully to Venezuela-have been menitionied in the imedia the crisis. It took courageous imieasures to as facin,g particular difficulties followinIg even1ts in] reestablish a fiscal surplus by cutting expenditures Mexico, and two that provide stronjg evidence on), amlonig others, exports subsidies, public sector that the best inisurance against systemlic risk is \vages and social security, wlile raisinigVAT rates good economic policy-Chile ancd Colombia. a.nd other taxes. Somiie of the remlarkable recent achievements of Argentine G[)P will not grow in 1995 but Peru are higlhlighlted in the Appencdix. will increase at the rate of 2 percent in 1996 (reg',ional forecasts of the mlaini imiacro variables Argentina appear in the Appendix). This is significantly less than in 1994, btit is still a favorable outcollme In late 1994.,Argentina enjoyed several giveni the imiagnitude of the Mexican crisis and advantages comiipared witlh Mexico: (a) its cur- the ri,idities of the exchange rate systeml. If any- renit account deficit was less than half that of thing, this imiodest growth response showvs that Mexico's; (b) it en joyed a credible political and Convertibility withstood a major crisis buat if ecoIIomlic leadership, (c) its level of international rapid growth is to be resuLmled, mnjor structural reserves remlainied high; (d) ptiblic debt iniatuLi- refoormlls are imperative.The currenit accoun)t ties were not concentrated in thte short ternm: (e) deficit should not pose any finanicin,g problemn mlaniy of its structural reformiis were deeper, (t) its (2.3 percent in 19995 and 2.2 percent in 1996). inflationi rate was extremiiely low and expected to As expectations stabilize in the comiinig mlontlhs remlaill so. and the modernization process continues, Argentina's tinanicial sector, however, is par- Argentina is anticipated to resuLmle vi'gorous ticularly vulnerable to negative externial shocks, growth. giveni the nature of the Convertibility Plan, uLnder wvhich high -powered money has to be Brazil flilly backed by interinationial rcserves.Thtus, the Central Baank has very limiited iresources to coIn- The country's stock market was the imiost front a run against bank deposits. After severely affected in the postcrisis days. losing Decemiiber 1994. the genteralized "flight for qual- one-third of its dollar value between Decemiiber ity" affected liquiditv across imiany LAC 2)0 1994 and March 1995. Investors' nervousniess economiiies. In the case of Argentin;a, a few banks translated inito a loss of interniationial reserves. had to suspenid temiiporarily the conver-tibility of There are, however, a numiiber of factors that deposits in order to avoid selling their assets at strong,ly indicate that Brazil is in a mlore solid distress prices following the withdra;wal of funds. positioii thani Mexico. First, the imiaturity of With assistance froml the World Bank and the Brazilian debt is more favorable. Second, whIen IDB the government is enlgineerling fa r-reach- the rel71 plan was launched the currenicv wvas ing reformii of the finanicial sector, facillitating the clearlv tindervaltied, providing roomii for appreci- mlerging of institutionTs, the streamlining of ation.Third. substantial productivity gains took provincial banks, the strengthleniing of supervi- place tip front. Fourtlh, the consuLmlptioni booml siOI and the imiipleientationi of a broad deposit that accompanies successttil stabilization is onIlv insuranice systemi.5 beginning, and the aLItitorities are aware of the Under crisis coniditionis a chIanige in the nieed to keep it tinder control. Fifth, internlation- 8 L A T I N A M E E i ( A A F T E 1, M E x I c 0 al reserves are high; and sixth, the currenit necessary. Tlhus, a redefinitioni of the role of the account deficit forecast for 1995 is mlodest. state witllin the economiy, enconiipassing policies However, the mluch larger than expected trade for deregulatioll, privatization and fiscal, financial deficit in December 1994 and in the first quarter and social security reforms, are central to the of 1995 suggests that before the eruptioll of the overall eftort. On several fronts the reform Mexican crisis, the external situation in Brazil process is already unlder way. Since 1990 foreign was beginniinig to deteriorate. exchange controls and the list of prohibited In contrast to markets elsewhere in LAC imports have been eliminlated, fiscal incentives (particularly Argentina and Mexico), Brazil's for exports and external financinig requiremlenits exchanige rate has not been under protracted tor imports abolished, granting of imlport licenses pressure and capital flows have not been as capri- Made automiiatic, and a mlulti-year tariff reduction cious. Interest rates have been rather stable (but programl imlplemiienited. Further trade reformls high); a policy-induced rise in interest rates xvas will be conducted under the aegis of the MER- ultimiately effected in the wake of the wideninig COSUR agreemenelt witlh Argentina, Paraguay, of the exchange rate banid in March. Such rela- aind Uruguay. On the negative side, recently tively stable economllic and financial develop- sonict protectionist policies have been established, mlerits in Brazil can be explained by a variety of by whiclh tariffs on cars and durable goods have factors: confidenice in the stabilization plan and been increased and broad ranginig anti-dumiipinig in low intflationi; a modest currenit account deficit powers introduced. Fortunately, steps have been partly finaniced through autonomiious capital taklen to reduce the participation of the state in inflows; and large interniationial reserve holdings. various sectors of the economiiy and to encourage Furthermnore, domlestic debt is low and is largely comlpetition and reduce regulation of economiiic deniomiinlated in domlestic currenicy. External activity.The privatization programl initiated in short-terml debt is also mlodest. 1 99 1 has thus far resulted in sales of 30 federal However, sustaininlg, thle presenit program governmllenit-ownied enterprises, realizing revenue will require a substanitial tiglhteninlg of fiscal poli- of US$8.6 billion. The nieed to strengtlheni and cv in 1995 to assure that the cyclically adjusted deepeni this reforml process has becomle mlore operational balance of the publiC sectol- is in sur- prressillg, followinig recent events in Mexico. plus. Fiscal accounts have beenl in balanice thus In all, it is expected that in 1995-96 the far onlv as a result of the strong boomi in coIn- Brazilianl econlomy v will grow at respectable rates suLmlptionI since the initroductioni of the real; this of 4.5 percent, with a currenit account deficit of indicates the presence of a significa it unlderlying, inodest mlagnitude in both years (1.9 and 1.7 fiscal gap that has to be addressed througlh botlh percent of GDP in 1 995 and 1996 respectively). tax and expenditure policies. In addition, a large On the negative side, inflationi-though signifi- quasi-fiscal deficit is projected to emnlerge in cantly loxver thani in the recent past-will still 1995, giveni that the Centr-al Bank has exteLnded remain on the high side, certainly in 1995. wlhen support to several state banks to cover- operating it is expected to be around 35 percenit. losses. Also, the sharp r ise in real interest rates froml early March 1995 will exacerbate the inter- Venlezuela est paymients burden on the Central Bank and the federal and state governmiiienits. The counltry entered a deep crisis even Inflationi can be reduced in a sustainable before the recent Mexican developmlenits. By iso- mlanniier only if fuLndamiienital structur-al reformls latinig itself fromii international capital mlarkets- are imlplemiienited in support of miacroeconionxic bv introducinig stern controls on capital flows- policies. Above all, reformiis to elicit a supply Venezuela has not been severely affected bv the response under the newly established stability, to Mexican crisis. In fact, the economiiic situation promote investmiienit and the flexible use of sav- xvas already uLnder suchi strain that events in ini,gs and to ensuL-e efficielnt use of caIpital are Mexico could not mlake it much worse.The Q U N I N K I N I N f I H F P A C E *9) prospect of smaller capital inflows to the regioni prodtice a temiiporary reduction in the rate of only makeVellezuela's prospects dimmiiiier, capital intflows, Chile could sustain this reduc- Of the mnajor LAC economies.VenCezuela is tino given its smlall current account deficit, lhigl the only one in wvhich the fiscal situation1 is out savings ratio, and comifortable international of hand. The fiscal deficit is almlost 9 percent of reserve position. GDP. There has been a dramlatic contr-actioni of The Imlost recenlt estimates suggest that private investment. wlhich helps explain why prospects are briglht. Growthi is expected to output growth was negative both in 1993 and remiaini at around 6 percent (5.9 in 1995 and 6.5 1994. The situation is not expected to imlprove in 1996). inflationi should continue its gradual significantly any time soon. In addition, there is a declinle (8.2 percent in 1995 and 6.8 percent in geeneralized banking crisis, capital controls, highl 1996) and the current account deficit should inflationi (71 percent), and a real exchalnge rate remain well unlder contr-ol (with a temlporarily estimated to be ovel-valued by 17-25 percenit. high level of 3.1 percent in 1996). posing no with a fixed nominal exchanige rate. th-eat to the balance of paymlenits position. Short-terml prospects are poor. wvith GDP) expected to decline 1.5 percent in 1995 ainld to Colomlvbia inicrease onily 1 percenit in 1996. Inflation is pro- jected to be around 70 percent in 1995 and 1(0) Colombia was the only mnjor countrv in percent in 1996. As a result of the severe reces- the remion in whichi the stock mlarket rose at the sion , significaint currenlt account surpluses are s iam tine that the situation was unlraveling in expected for the near future. Mexico. Even though Colombia has been run- ninig currenit accounlt deficits that are on the Cliile highi side, foreigni investmiienit in the oil sector has beenl dynamic enougLh to produce an increase in The examlple of Chile is pa;rticularly inmpor- interniationial reserves. The currenit accouLnt tant to highlight, becatise it represents a case in deficit is partially explained by an imlportanit wNhich a stable macroeconomic environment has recovery both in private and public investmlenit. been the normii for several years and onle in There hlas been, however, a decline in nationial whiclh miost structural reformls have beeni in savinigs and for the deepeninlg of somle structural place for quite a long period of timle. Chile is reforms-particularly in the financial system and the only country in the regioni in wlich capital capital mlarkets-in order to mlobilize thema mlore inflows have been dominiated by direct foreign effectively. investmietnt. Gross foreigin investmlent increased Even thoughl mlacroeconiomic stability is from I percent of GDP in 1986 to 9 percent in not immilediately threatened, Colomibia still 1994. mlakinig the overall balance of paymllenits shows relativelv high rates of inflation. The newv mulch less sensitive to short-termi) changes in admiinistration of President Sanmper is relying interest rates and in financial market perceptions. quite heavily on an incomlies policy based on1 the In addition, the deptlh and strength of Mexican pacto. Whether these policies will have Chile's reforml progirama have brought about a the desired results will largely depend on the continiuous increase in productivitv.That mlade accompanying fiscal and mlonetary stance. it possible to maintain export-led gIrowth in In addition, and notwithstanding a tradition spite of real exchange rate appreciation. While of macroeconiomic discipline, Coloniia's strmc- the peso appreciated 25 percenit in real termls ttiral reformi program is recent and, in some betweeni 1990 and 1994. productivity has seise, not extremiely amlbitious. Recent events in increased by an average of 3.8 percenit per year. Mexico have spurred protectionist pressures by Chile's economic fuLndamiienitals and quaLlity several interest glOUps, to wlhich the governiniient Management suggest that they can deal wvell should respoond with firmnliess. Deepening and wvith potential risks. If a regionial effect w%ere to strengthening of reformls is required to comple- () l A T I N A M E lRIA ( .N A X E l M L X I( mleint a good macroeconomic record with a accrue to the population at large, macroeconomii- more sustailnable growth prospect. ic stability and the remloval of allocationi distor- We expect that Colombia wvill continlle to rions xvill be necessaryx but certainly not sutfi- grow at a brisk pace (5 percent in 1995 and 5.5 cient. Recenit and ongoing reformls will have to percent in 1996), withi inflation only graduallv be comiiplemlenited witlh policies that address edu- declininlg (to around 2(0) percent in 1995 and 16 cation, poverty and the distribution of wealtlh. percent in 1996) and a currenit accounlt deficit We now turn our attentioni to these pressing that, though on the high side, should be finaniced issues, ones that will have to be confronited in withl large foreigni investmiienlt anid imiediumi- and the immiilediate future. long-term debt. In order for the region to consolidate its gro'wth prospects in such a way that the benefits 11 CHALLENGES I)URING THE LAST FEW YEARS LAC countries have instituted mi.ajor eco- nomilc reformls, wvhich have beg,unt to generate results as exports expanded, inflationi declinied, productivity grew fast and personal inicomiie increased. In spite of this progress, the LAC regionl still faces key challenges, which becamiie eveni imiore evidenit followinig recent events in Mexico. The mlost importanit of these challeniges is the nieed to cons5olidate the refornms by expanding the political coalition that supports the mlodernizationi process.This, in turni, will require two fuLn- damental developmenits: First, the rate of growtlh has to accelerate significantly. Second, the fruits of the reform should be distributed in a way that reduces thie reg,ion's legendary degrees of inequality and poverty.6 Acceleratin,g growtlh while reducinig poverty oniy.What is encouragilln is that regional leaders and inequality will require intenlsifyilln somle and the populationi at large-as evidenced bv the reformiis already in place as well as imlplelientintig results of the last seven nationial elections in a series of "seconid generation'" eftorts. The new wliclh pro-reform-l candidates, maniy of theml reforms will have to chanige iicroeconomic and incumbents, won by wide margins-are aware of political incentives: they wvill have to strenigthen the need to miiove expeditiously in implementing institutions, rebuild the state, thoroughly reforml the next rounlds of reformls. civil administration and imodernize the judiciary. In short. thev will have to create the framework A. THE NEEL) 1ro ENHANCE that will allow investors and workers to operate GROWTH efficiently and harmloniously, while permlitting, them to coimpete successfully in the world ecoin- The recovery of the first half of the 1990s 12 L A T I N A M E R I C A A F T E R M E X I C O made LAC one of the most dynamic parts of the Table 1. Growth in Export Volume, Latin America and East Asia global economy. In spite of this, and even before (annual percentage rates) the Mexico-induced slowdown of 1995, its rate 1982-87 Early 1990s of growth was not sufficiently high.A recent Latin America 1.8 6.0 Argentina 0.8 12.8 World Bank study estimated that a minimum Bolivia -5.3 4.5 average growth rate of 3.2 percent per annum is Brazil 8.0 1.5 required to reduce the absolute levels of poverty Chile 7.6 7.4 requred o rducethe bsoute evel ofpoet Ecuador 2.4 9.6 in the region.7 This has been the approximate Guyana 1.5 0.4 rate of growth actually achieved during 1991-93. Honduras 1.8 -3.8 Jamaica -2.0 8.5 This means that after all the reforms, the efforts, Paraguay 9.2 17.2 and the accolades from the financial media, the Peru -4.0 1.3 region as a whole is making little progress Uruguay -0.5 4.8 regionas a wholeismakinglittleprogresVenezuela 2.1 7.5 toward breaking out of the quagmire of poverty. East Asia 9.9 10.1 Accelerating growth to higher levels xvii require Hong Kong 17.6 16.4 policy reform in at least the following six areas: Indonesia 7.0 4.2 competitiveness, domestic savings, infrastructure, Malaysia 5.8 175 rebuilding the state, labor market reform, and Philippines 2.4 8.4 educational reform. Singapore 11.2 14.5 Thailand 10.7 18.1 Sources: ECLAC, Statistical Yearbook for Latin America, IMF, Competitiveness International financial Statistics Exports are at the center of the new LAC development strategy and are becoming the broadened to reach the sub-national level. "engine of growth." Until now, this approach has Second, labor markets and the educational sys- worked rather successfully. Between 1987 and tem will have to be reformed (see the discussion 1994 regional exports grew at around 10 per- in subsection B below). Certainly, a trade regime cent per annum in real dollar terms and 6 per- characterized by openness to the rest of the cent in volume (Table 1). Moreover, during this world must be kept in place. period they have become more diversified, In the aftermath of the Mexican crisis, most reducing the region's vulnerability to external countries in the region have continued to move shocks. Increases in productivity induced by briskly toward reducing resource misallocation. opening the economies and, until recently, com- For instance, on April 1995, Mexico approved petitive real exchange rates in most countries, legislation to open transportation, storage and have been behind this positive record. distribution of natural gas to foreign investors. In the years to come exports will have to The deregulation of telecommunications markets accelerate further if economic growth is to has already been approved by the Mexican increase. Historical data suggest that rapidly Congress. In Venezuela, the opening of the state- growing countries in different parts of the world owned oil holding PDVSA to foreign investors is have experienced, for long periods of time, a rate under consideration in Congress. If approved, the of export expansion that exceeds income growth legislation will allow foreign companies to hold by a factor of around two. In order for exports to up to 65 percent of joint ventures. In Peru, grow rapidly in a sustained fashion, it will be Petroperu was sold to private (both local and necessary for the region to increase its interna- foreign) investors during 1993-94, and the coun- tional competitiveness through continuous pro- try's two main refineries are expected to be pri- ductivity improvements, which will depend on vatized during 1995. In Brazil, although two basic developments. First, deregulation and President Cardoso has ruled out the privatization privatization will have to be furthered and deep- of the oil company Petrobras, electricity-generat- ened. In particular, these reforms will have to be ing industries are expected to be sold to the pri- Q U I C K E N I N G T H E P A C E * 13 Table 2. Intraregional Exports in LAC (percent of total exports) Average Average Country 1980-85 1985-90 1990 1991 1992 1993 Argentina 19.0 227 26.1 29.3 32.9 41.4 Bolivia 49.1 52.9 44.8 48.4 38.7 37.3 Brazil na 12 5 11.6 16.7 22.0 25.2 Chile na 14.6 12.6 14.8 17.0 20.0 Colombia 15.7 14 2 16.1 21.6 23.8 25.3 Ecuador 17.0 13.6 17.7 17.1 17.9 21.0 Mexico na 6.7 6.0 6.7 5.0 4.9 Nicaragua na 14.8 21.9 26.2 28.5 27.3 Paraguay na 49.3 52.4 46.7 50.2 49.0 Peru 15.8 14.9 14.6 18.5 180 18.7 Uruguay na 33.5 39.5 40.7 41.8 51.2 Venezuela 11.4 10.0 11,9 12.6 17.1 20.0 Source ComTrade, Un,ted Nations Internationa T,a_e Database vate sector within one year. In May 1995, a con- threat of using new "standards"-on labor and gressional committee voted to open the the environment-in trade policy is likely to telecommunications sector to competition, jeopardize not only the region's growth, but the allowing private local and foreign companies to world trading system. compete with the state-owned Telebras. In The volume of intraregional trade in LAC Bolivia a privatization scheme has been estab- has exploded since the beginning of the 1990s. lished in which a significant portion of any Intraregional exports rose from US$16 billion in divested company is given to its workers and the 1990 to more than US$32 billion in 1994, or rest sold to investors. The proceeds obtained from 3 percent of total exports to almost 22 per- from the latter are immediately capitalized in the cent.8 MERCOSUR is the most dynamic same firm, with the end result that assets are group, with a total US$11.4 billion in intrare- more evenly distributed and firms have a much gional exports in 1994.This represents a three- sounder balance sheet. fold increase in five years, a performance that is Improving domestic competitive conditions, enhanced by the simultaneous boost of 28 per- however, is only one of the factors that will cent in exports to the rest of the world. Trade affect export performance. At least as important within the Andean Pact countries also increased will be the evolution of the world trading sys- in an impressive way, with exports reaching tem.Two factors are particularly relevant in this US$3.5 billion in 1994. Bolivia, Colombia, respect: First, the implementation of a hemi- Ecuador andVenezuela have already formed a spheric trading system based on a high degree of customs union, and Peru is expected to join openness to the rest of the world-what has toward the end of 1995. In November 1994, all been called open regionalism-is likely to help five countries reached agreement on a common expand exports significantly. Intraregional trade external tariff, to be implemented later this year. has increased greatly in recent years, but its level Intraregional trade doubled from 1990 to 1994 is still below that of other regions (Table 2). in the Central American Common Market, Even though Chile was invited to join NAFTA recovering from the meager levels of the 1980s. during the Summit of the Americas, the In the case of CARICOM, implementation Mexican crisis has created doubts that a free problems and the more heterogeneous composi- market zone in the Americas will be established tion of the group resulted in the virtual stagna- any time soon.This is unfortunate because no tion of regional trade at the low levels of the late action could do more to stimulate intraregional 1980s. trade than NAFTA's expansion. Second, it is The new wave of trade integration strate- important that industrial countries reduce their gies contrasts sharply with the early attempts of level of protectionism. Some industrial nations' the 1960s. LAC nations have now embraced a 14 L A T I N A M E R I C A A F T E K M E X I CO so-called "open regionalism" approach according conflicts of interest.Thus, this initial outburst of to which the increase in intraregional trade is bilateral pacts should be followed by a process of encouraged without imposing additional barriers orderly convergence. to trade with countries outside the area.9 As a result, LAC economies have become more inter- Domestic Savinigs dependent at the regional level, without slowing the drive for increased involvement with the rest The accumulation of capital-both physical of the world. In addition, the recent approval of and human-plays a fundamental role in the GATT and the subsequent creation of the World growth process. Countries that grow faster Trade Organization have been important ele- devote a higher proportion of their GDP to ments in assuring that regional trade growth will investment and have developed a capital market not clash with a multilateral trade strategy. that helps channel these funds toward high The integrationist booml has given rise to return projects. A faster rate of capital accumula- the establishment of several overlapping pacts. tion requires, in turn, an increase in domestic About 30 of these second-generation agree- savings.The LAC region has traditionally had ments are in place, seeking the effective liberal- low saving rates: In 1980 the region saved on ization of trade in the area within increasingly average 19 percent of its GDP; by 1994 this ratio shorter schedules. The first sign of this trend was basically unaltered. This contrasts with fast- was the bilateral pact between Argentina and growing regions, which save up to 35 percent of Brazil, signed in 1986, which led to the forma- GDP (Table 3). Low savings rates are, in fact, one tion of MERCOSUR in 1991. Its member of the most serious constraints faced by the countries formed a customs union that is oper- region's countries in their effort to accelerate ating, with predictable imperfections, since growth."t' Recent events in Mexico triggered a January 1995. A common external tariff sched- significant slowdown in capital inflows, proving ule was introduced, though with a short but that foreign savings are not a long-tern1 reliable important list of exceptions. source of funds, nor a substitute for domestic The impressive list of bilateral and trilateral savings as a means for financing investment. agreements, often overlapping, will require a The most effective way to raise domestic careful coordination in order to achieve the savings is through higher public savings. This will desired level of integration and avoid periodic have to be achieved through further improve- Table 3. Regional Comparison of Private and Government Savings Rates, 1970-93 1970-1982 1983-1993 Q13 Median Q3a Average 01a Median 03a Average a. Private Savings Latin America 13.1 13.2 21.7 16.1 10.9 14.7 17.9 13.8 Asia na na na na 17.4 19.1 22.9 20.2 Africa 11.4 14.4 18.9 15.2 10.7 16.7 19.5 15.6 Industrialized 18.0 21.6 23.4 21.3 18.3 21.3 23.4 21.3 b. Government Savings Latin America -0.7 1.7 6.6 3.3 -1.3 2.4 5.5 2.2 Asia 0.0 2.7 8.8 4.4 0.0 1.6 9.0 3.9 Africa 1.6 0.9 2.1 0.6 -1.3 1.0 4.5 0.9 Industrialized -0.5 2.0 3.8 1.8 -3.6 -0.1 1.3 -0.8 c. Nationa'Savings Latin America 14.5 19.4 27.7 19.8 14.0 17.8 19.1 15.3 Asia 4.9 24.8 26.7 18.8 18.8 23.8 28.5 24.5 Africa 10.8 15.5 18.7 16.4 10.6 17.5 22.1 16.8 Industrialized 19.6 22.8 25.8 23.1 17.5 19.1 23.4 20.4 a. O1 iS the tirst quartile 03 is the thira quart .e. Source: international Monetary Furid Q U I C K E N I N G; T H E P A C E * 15 meiits in fiscal positions. Recent studies suggest recent work on savings is that there is a virtuous that increasing government savings by 1 percent circle between growth and private savings. Higher vill generate an increase in aggregate domestic growth increases disposable income, and encour- savings of around 0.5 percent. The specific cir- ages savings. Higher savings, in turn, permit a cumstances of individual countries will dictate higher level of capital accumulation, and thus, whether public savings should increase througlh reinforce growth. A strategy that combines an higher tax revenues, reduced expenditures or a increase in public savings with reforms geared at combilnation of both. Under most circumastances, improvilng the mobilization of private savings some reduction in expenditure is likely to be xvill provide an effective way of taking advantage optimal. In most countries it seems feasible to of this virtuous circle. reduce military budgets as a way to generate somiewhat higher public savings. Argentinia has Intfrastructure provided a pioneering example in that regard. Of course, that is not the case in some other coun- During mzost of the 1980s and the first half tries, where narco-trafficking and insurgency of the 1990s investment in infrastructure was mzovements pose a threat to the sustainabilitv of seriously neglected in LAC. As a result, the dem1ocratic institutions. region faces a serious deficit in powver genera- Efforts to raise public savings should be tion, roads, water supply and teleconiimunica- supplemzented by policies aimzed at encouraging tions. The World Bank has calculated that to private savings. Inmproving the efficiency of mzake up for these deficiencies and provide the domestic finaincial nmarkets will go a long way region wvith the infrastructure stock consistent toward achieving this goal.'' Comparative studies with an export-led growth strategy, investm1ent have suggested that an iimprovemiient in the pro- in infrastrLucture will have to amouL1t to approxi- vision of financial services, includinig an inately US$60 billion per year until vear 2005 increased confidence in financial institutionis, are (Table 4). Moreover, detailed analyses in the at the heart of higher household savings. Bank's [IIrld Decuclopmeut Report /994 show that The reform of the region's social security the quality of the services provided by LAC's systemas provides a second, and fundamienital. existing infrastructure leaves much to be desired. vehicle for raising private savings. Analyses have A region that turns toward the external sector to showiv that private savings are affected by the drive growtlh cannot afford to have third-class extent and coverage of governmllenit-runi social infrastructure. security systenms. If individuals perceive that The volume of infrastructure investment wheni they retire they will receive high benefits required for the next decade is substantial-rep- from the governm1lent, they will tend to reduce resentciig approximately 4.5 percent of regional the amount saved during their active days.12 This GDP-and mluch larger than the combined forcefully indicates that a social security reform commiitmltenits of the World Bank and the IDB. that replaces a governmlenit-funided system1 by a The bulk of the increase will have to come from privately administered one will tend to increase private sector investmiienit. Interniational experi- private savings. Regarding foreign savings, recent findiings Table 4. Infrastructure Investment Needs in Latin suggest that while long-terml foreign investmiienit America during the 1990s U5$ b0/hoc", er f enhances growth, it might well be the case that Sec/c' 1993,pces regona; CDP short-termil foreignl finanlcinlg stimllulates coII- Pjver 24 1 & Tr ansqcr 14 1 0, sumption, thereby substituting for domlestic sav- TC ebccr ai 10 11 ings. It is therefore desirable to im1plement poli- A/ate and Sanitaticn 2 s.9 cies that favor direct foreign investmeint over T,sta 60 4.4 short-term speculative flows. Sol r Bark Pecorl ,n'estrz' antt9tve Perhaps the most important fiindinig of 16 L A TI N A M E I (: A A F T L K M F X I O ence inidicates that an efficienit and credible regu- genieral equilibriumii model) suggest that if the latory fraiexework, overseeni by fully indepenidenit type of policies advocated in this report- anid professionial regulatory bodies anid commlllis- enhanaced private savings and comiipetitiveness sions, is a fuLndamiiental requiremlenit for gettinig a and adequate provision of infrastructure-are substantial private sector involvemiienit in infra- indeed unldertaken, LAC is very likely to grow structure investmnent. This is an area, however, strongly in the mieditumii anid longer terms. As is where even the mzost advanced reformiiers are discussed below, our owni projectionIs suggest that lagging behind and where significanit effort will the imuproveimlenit in fLundaimienitals generated by have to be made in the niext few years. The these policies are likely to result in an average World Bank is leadinig a drive for increases iI rate of growth for the regioni of 6.3 percent per inifrastructure developmzenit, by wvhichi it serves as allnluL11 for 1998-20(0P2 a catalyst to help counltries mobilize fromii private sources the large volumile of fhulds necessary. B. POVERTY, INEQUALITY AND wlhile also providing financing. Its maill conltri- "SECOND GENERATION" REFORMS butioin will come througlh anialytical support for policy reforml to open the sectors to private par- Poverty and inequality have long been ticipation, whiclh is already proceeding rapidly in salient features of LAC The inability to deal the power sector. l3 eftfctively withl these issues is, perhaps the sad- Reducing perceived counitry risk is a funda- dest illustration of the traditionial policies of gov- mental requiremiienit for iniducilng foreig4ers to erini1enit intervenition. Incomiie inequality pre- inivest in domiiestic infrastructure projects. Perhaps cedes the debt crisis and the adjustmiienit pro- the imost imaportanit step in that regard is for the gramiis of the 190X(s; in the late 197(I s the per- LAC coun1tries to be gr-anited inueircstmi igradc rat- celtage of inicomile received by the poorest 20 ings by international agencies. In determininzg cetit was lower in LAC than i mi), other part the degree of risk involved ini doing business ini a of the developing world. 4 The debt crisis nega- particuIlar country, rating agencies focus especial- tively affected an already battered social picture. Iv on1 its ability to generate, in a tillmely fashion, Althoughi a nlumllber of couL1tries reacted to the the foreign exchanige required to imieet contrac- crisis bv imaplemiienitinig emiiergenicy social pro- tual pav'meints to investors. In determininltt,g graills the overall level of poverty and inequality wlhetlher this requiremiienit is imiet, these agelncies nievertheless inicreased in nmanv couiitries. consider the niatuL-e of capital and exchange con- A dozeni years after the debt crisis, one of trols, the quality of local regulatory laws, and the the iailn-if n1ot the imain-challenges in LAC is imipartiality anid etfectiveness of the judiciary to reduce poverty and reverse decades of Making major imilproVemlelnts in all three areas is illequalities. Addressing the needs of the poorest an uLrgent task for the couLntries In the regiol. strata of society is not just a social issue, but also Infrastructure inivestmiielnts require long-ter-mii a political one. This has been made even m1ore financing. In imiost LAC couL1tries, however, capi- evidenit by the Mexican crisis. InI Mexico, social tal markets are still in their initancy, xvith ftulnds tensions g,enerated un1certainty that rocked the for longer mlaturities being genlerally unavailable, financial markets and, as argued in the second Memaories of inflationiarv years and bankilh. part of this report, contributed to the unlleaslillng scanidals. uLtested legal structures anid young reg- of the crisis. Only' to the extenit that poverty is ulatorv frameworks, still stanid in the way of trulv reduced anid inlcomlle distributioii becoImies imlore imiodern financial mlar-kets. Movinig swiftly toward eqtmal, can the structural reformas becomle sustailn- reforming tlhemii will nlot onllv help increase able. Moreover, atteniding to the needs of the domiiestic savillgs bUt Will also facilitate inivest- poor for education, n1utritioni, and health will mlenit in infrastr-ucture, have dii'ect etfects on1 economic growth. Recent calculationis prepared for the 1II'rlid L)uring 1'94-95 the World Bank unidertook Den'clopumtet Rpcort 1995 (usig, a worldwide several couLntry studies on1 the social conditionis Q U I C K E N I N G; T H E P A C E * 17 Table 5. Poverty in Latin America and the Caribbeana (percentage of population living in poverty) Poverty Extreme Poverty Early Mldlalte Early Mad/late Country 1980s a/Sos 1990s 1980s 1980S 1990s Argent na (1980, 1986, 1993)' 16.2 51.1 17 6 3.3 21.1 3 4 Soivia (i992) na na 720 na na na Braz I (1980, 1986, 1990) 69 0 a0.0) 43 0 na na na Chile(1987 1992) na 28.0 240 na 170 19. Cc obnia(1988. 1992) na 33.8 32.7 [la 187 17.1 El Salvador (1992) na na 38.3 la na 9.9 Guatema a (1989) na 75 2 na na 57 9 na Gua/ana (1992) na na 43.2 nal na 27 7 Honduras (1989. 1993) na 5,5 S3.0 n 36.0 32 0 Jamaica (1989, 1992) na 26 9 34 2 na na a Mexico (1984, 19899, 1992) 24 7.5 25 9 6.1 7. 82 N caragna (1993) ua na 50.3 na na 194 Paracguay (1990) na na 3.5 Peru (1982 1989. 1992) 465 52.0 537 21.0 250 21.2 Trinidacl & Tobago (1992) na na 21 1 na la 11.0 Ur uguay (1980. 1986) 11.0 150 na a na Fla Venezuela (19382 1989) 22.3 31 4 na 10.3 202 n a a PAver. sx defirerl as the headccvirt ndex, roFe mprp: Tier- of people %e1- ase dee, cr1 1t De poao (or Witenr ine y por i. A t1-ucmr the p,oe ty yie ior the i' gent npie) s crjntry spec f c, ir al essex it s ref rlee I ce tlhe basis or tlhe cost etc basic L.ass.et cf rc ,cecs b. t e-'O to Me-recil tari Buren,s A re,. The qwr1 ficari relr ase rtre rO id to late 198is is, tr a crest eorcot, troe resu o of orer hiAh At dticrn. na Not aa saole SovWce WAot Icl Bark arcd ErL ^A and the extent of poverty in the region. eral, it takes timie for the fruits of faster growth Although methodologies are country-specific, to spread over the most vulnerable and poorest Table 5 clearly shows that thie Mexican situation segimienits of society. A numiiber of authors and is by no means unique. Both poverty and institutions, includinig the World Bank. strongly extreme poverty are widely spread across the argue that there is a need to implemiienit a two- region. As expected, poverty is more significant prong approach toward povertv and inequality, in rural areas, though in some cases even the where faster growth is supplemented with social urban indicators are disturbingly higlh (Table programs targeted at providing services to the 6).15 In the next few months additional case neediest. 16 studies will be completed, providing a relatively A recent World Bank study oIn several LAC complete regional diagnosis. countries provides important information for the For many years, acceleration in growth was design of successful targeted social progranms.'7 It considered the maini prescription for reducing was found that four fundamental factors deter- inequalities and poverty. Increasingly, however, minie the probability of being at the bottonm of enmpirical evidence indicates that, although very the distributional scale: education, gender, eth- im1portanit, higher growth is not enough. In gen- nicity. and regional issues. Education appears to be the single most imlportant determiniant of Table 6. Urban and Rural Poverty in Selected inequality. This study, as well as others, also found Latin American Countries that, other factors being equal, the probabilitv of (percentage of popu ation ving in poverty) being at the bottonm of the distributional scale is Country Total Oen fi,ar higher for females. Moreover, poor womiien tend Colombia (1992) 32.7 19.8 50 5 El Salvador H1992) 38.3 36 41 4 to be older, and have fewer opportunities to Guaternaia ('989) 75 2 57.2 85.7 improve their skills through additional training Mexico (1992) 25.9 22 4 31 0 ac Nicaracua ('1993') 50 3 .31.9 7 .1 and educatioi. In nlany countries, ethilclty iS Paraguay (990) 20.5 19 7 28.5 directly related to poverty and inequality. For Soe'ce WForld Barn, severals reorrspeCetiC r eperts examaple, in 1989 only 40 percent of Guatemala's indigenous population had more than 5 years of I 8 L A r T N A M F R I ( A A F v L 1 M E X I C educationi, comipared wxith 76 percent of the Iy weak. The latter imlplies that the benefits of noni-indigen)ous population. Countrywide aggre- the schemiie are widely spread in the commiluniity. gate data tend to hide significanit reogional varia- tionis rvithiti counLtries. Brazil provides the starkest Rebuilding the State example of intracouLitry differenices iII develop- mlent: Rio Grande do Sul has social indicators Designing and imiiplemweniting effective pro- comiiparable to those of Portugal anid Korea, grains to tackle poverty and inequality will w\vile the region of Paraiba is not significanltly require resources and, perhaps more imiportanit- different from East Africa. ly, a thorouglh rethinkinig of the imiechaniismils Both froml the point of viewv of equity as throtughl wvhich social services are delivered. In well as a mzatter of good economics, the regioni mlaniy LAC couLntries-Venezuela being, per- should play close attentioni to the redistributioni lhaps, the best example-the mlaini issue is not a of assets. Policies that, in the name of fairness, lack of finds, but the inefficienIcv witlh which created a hostile environmiiielnt for both domlestic programiis are run. The lack of administrative and foreigni private sector initiative are a thiln,g of capacity. the reluctanice of governmlienit emlploy- the past. However, in the searchi fur a mlore effi- ees' uniiolns to mlodernize themselves, and the cient and productive economiic enivironmiiienit, absence of accouLntability mneclhaniismiis, have somle actions that imlply a inor-e equitable redis- tended to create a situatioll of grave nnisman- tributioii of certain assets miiglht well be an inte- agenieiit and inefficiency. gral part of a successfuil economiic strategy. OCnly to the extent that these issues are In this regard, at least twvo issties are xvorth addressed through mnajor administrative inenitioninag In somie counitries the lanid tenure reforiims-which imzplies no less than rebuilding svsteini is a maljor cause of macroeconomic ineffi- the state-will the provisioni of social sectors ciencv and stag,nationi in productivit VWhen improve to an acceptable level.The acceleration unniecessarily large plots of land are left idle or of growth and the reductioni of poverty and are devoted to grossly inefficienit lanid-intenisive inequality wvill require imiplemlenting a series of activities, policies that strive for the redistributioni "seconid genier-ation'" reforis. In contrast with of land make great sense. Ot- course, redistribu- muost of the policies undertaken in the last few tion should be carried out inl consultation wVith years, xvhiclh were addressed at correcting gross the miiarkets. On the supply side, currenit inefficienicies and nmacroeconomic disequilibria, landowniers have to be comipenisated at mlarket the new reformiis will have to deal with more prices; on the demand side, specific care s,hould subtle issues, including the strengtheninig of insti- be given to ensure that recipients of land will be tutions, the retform of civil adminiistration and those wlho would be willing to use it in the the modernization of the judiciary Perhaps the inore efficient and productive manner. In any mlost difficult aspect of this new phase is that rel- event, the conninoin practice of bailing out large atively little is knowxv about creating the type of fariners wheni land prices fill significantly should institutions required to miiove forward on the be discontinued, path toward mioderniization. Public sector divestiture in mlaniy cases also Because of its owII nature, the initial stage creates roomn for asset redistribution. An interest- of the reforml process was, to a certain extent, inig case, already mzenitionied, is that of Bolivia, rather simiple. After all, miany of the policies were where privatization has been carried out through designied anid imiplemiienited directly by govern- a mlechaniismii that implies capitalization) of divest- ments, wvith little or no need for Congressional ed firmls and partial ownierslip by employees, approval. They were adminlistratively simple, with The formiier ensures that revenue froml privatiza- amlple theoretical support amid withl several prior tiOII is not devoted to fin;anice current aovern- practical experiences to beniefit fromz. Rather inenit expenditure, but rather to enhanice the than the creation of new institutions, they capital base of firmus that wvere foarimerly' financial- imiiplied the downvsizing of the governmielnt. l (Q LI ( k F N I N ( T H E P A ( F * 1 9 The challenge that lies ahead is formidable. For- vidual capitalization accounts and minimumtiill ser- tunately, recenit evenits in Mexico have reminided vices assured by the goverinmenit would go a techniocrats, politicianis and the general public lonig wav toward reducinig the currenit degree of that the deepeninlg and broadeninlg of the reformii distortions. This systeml reduces the cost of labor, process has to be performiied, anid sooin. Decrees encourages savings and provides a boost to capi- that reduced tariffs or liberalized interest rates tal imiarkets by developing institutionial investors. were the typical instrumilent of the initial stages The regioni's labor legislation has a long of reform: in what lies ahead new institutionis traditioni of trying to protect employmiienit stabil- will have to be created, and existinig onies will ity This has been done througlh a series of mlea- have to be reformed. And it wvill no lonoger be sures, inlcluding limitationls on temporary hiring the case that chaniges vill be ''evenily'' distributed and imnposilng substanitial costs-in the forml of amiiong imemibers of society, as was thIe casc tfor severanice paymiients-oli dismnissals. These poli- example, wvith tight imionetary policy to reduce cies had tvo conisequenices. First, they inicreased inflation In whiat follows, specific groups will the cost of labor, discouraging emliploymilent cre- win at the cost of others. The imiiplemiientationi of ation. Seconid, because of the specific way in these changes will be costly in political termiis, wvhiclh the legislationi was put inito effect, the anld Much imiore comllplicated thanl previous onles. policies strongly discouraged traininig activities anld the acquisitioni of new skills. What imiakes Labor M'arket Reform existing severancc paymlent schemiies particularly iniefficienit is that they are related to the worker's The delivery of social services is at the cen- tenure ill the firm. This introduces somiie serious ter of the issues of poverty and equity at the and arbitrary distortionis, as firmiis xvill tenid to samiie timie that it is a pillar toWard achieving a retain older workers, eveni it they are less pro- imore productive work force. Labor issues are also ductive thall others. Relating severa mice pay- at the heart of any' attemiipt at enhlanicinig coinI- mlnelnts to years oftservice also reduces the petitiveniess. For decades LAC counltries used emiiployers' incenitive to invest in humiiani capital labor legislation as a tool for achieving social formiiationi, especiallv if skills are not firmii-specifL goals. Millimumul wages, job protectioni anid relat- ic. Tranisforminig severanice payviienits inito a ed imieasures were thought to be an efficienit wav deferred comiipenisationi schemie, or replacing of transferrinig incomiie anid protectillg the poor. thelml by uLleiniploy'inenit insuL-anice systemiis, Although these policies xvere well initeiltioned, would greatly increase the degree of efficienicv theyv ended up creating overly rigid labor imiar- of labor m-iarkets. This has been) par-tially donie in kets that were uniable to responid to the changing sollme countries. conditionis of the world econoniy'. However, the Existing labor legislation ill iiiost of LAC miarket-orilented reformiis iniipleiiienited in LAC pre-dates recent mnarket-oriented refor-miis, amid since the 1980s have barcly touclhed labor miar- encourages conltronitationial, lonig anid costly bar- ket legislatioll. gaiinl processes. With the exception of Chile, In mlost LAC countries social security coIn- the process is similar across countries. Unions tributions are seen as pure taxes, not as a colllpo- Wvith leg,al represenitationi propose a collective neint of total compenisationi package. 1' As a contract and emlployers Imlust respond. The state result, they introduce serious distortions that becomiies part of the ne;gotiations froml the increase the cost of labor and reduce its imiobility beginning, and the final agreement applies to all Moreover, in ulost countries hle social security workers. Strikes have been one iiiiportanit ImlechI- system is financially insolvxent, imlposing addi- an)ismnI used to resolve disputes. In mlost COUnI- tional costs by contributinig to the fiscal deficit, tries, in a texv cases, workers are paid even if on Replacing the region's pay-as-vol-go pension0 strike. The most important cost to firnnis is the regimiies, xvhere there is n1o lilk between comitri- prohibitioni on llirinig temporary replaceiiienits. butions and beniefits, by a comiibinationi of indi- All otfthis encourages coiifro'otationial relations 20 L A 1 I N A M F It I (CA A F I E It M E X I o () that hinider an efficient use of resources and tend been largely propelled by increases in productivi- to reduce the private sector's ability to comapete ty fueled by the accumutilation of humilani capital. inter natio nallL A series of recent em1pirical studies have strongly But perhaps the m1ost serious aspect of labor supported this viewv, indicating that the existence relations is that in many countries public-sector of a highly educated labor force, wlhose skills unions-and especially those in the health and imlprove rapidly year after year, has been partially education sectors-exercise a trem1enidous politi- behinid the tremenidous econom11ic success in cal influenice at the sam1e timie that they obstruict Korea, Hong Kong, Singapore, Taiwan and other any attem1pt to introduce accountability, reformii East Asian countries. Table 7 presents data on their operations and improve the delivery of recent educationi attainmient for a group of Latin public services. Reformingg labor legislation. anid Amzericani countries. Informzation on three of the "I-einventing'' the labor mlovemiienlt as trulv East Asian mir-acle countries-Hong Kong, demzocratic, inclusive and non-confrontational is Korea and Singapore-is also provided for com<- one of the mzost difficult challenges that LAC parative purposes. This table shows that wlile will ice in the future. This will not be an easy there are significant differences in educatior cov- task. But if it is not attempted and, mzoreover, if erage across Latin Amzerica, in every category results are not obtained, the economic and social \vith available data, educational coverage in the ftiture of the region will be clouded. East Asian "tigers" significantly exceeds the aver- age for LAG. Educational Reform Incoimplete coverage is not, however, the only problemz \vith the Latin Amzerican educa- There is now abundant evidence froml the tional system. A recent World Bank study has rapidly growing nations of East Asia that Success- found that the average qiiality of Latin Amaerica's ful com1petition in the international marketplace primary education is dismal. For example, an demzands flexibility. Firmls mLust be allowed to international comlparative study on reading abili- readjust their production miilx according to rapid- ties of 9-year-old childr-eni found thatVenezuelan Iv shifting comlparative advantages and workers studetnts rankied last out of 27 countries;Trinlidad have to be appropriately educated. The limlited and Tobago studeints did better, but still sigllifi- coverage of the Latin Amaerican educational sys- cantly' beloxv the average A 1992 study on sci- tem1, its lack of science/technology emphasis, and enice anid mathematics achievement for 13-year- its generally low quality stand squiarely in the olds fouLnid that Brazilian studenits fromz Sao xvay of im1proved productivity Only to the extent lPaulo anid Fortaleza were outscored by studenits that the dual objective of a flexible labor market froma Korea,Taiwan, Israel.Jordan and China, as and an imlproved education system are achieved well as by students froml every developed couII- will the Latin American cotuntries be in a posi- try in the sample. The only counltry Brazil tion to systeimatically grasp new export opportu- outscored was Mozambique. Finally, a 1992 study nitits as they' present themlselves. If these reformls on mathematics and science for 13-year-old stu- are not uLndertaken, new export markets will be dents in five Latin Amlericani counltries- captured by other nations, ancd the Latin Argentina. Colombiab Costa Rica, the Amzerican countries will be left (onice again) on DoMnMican Republic andVenezuela-found the sidelines, that, xvith the exception of elite schools, in mzost The accuMulation of humLlani capital, cases test performance was significantly below through increases in the coverage and quality of that of ''average' countries, such as Thailanid and education, con1stitutes one of the fundamental the United States.- pillars of successful developmeniit strategies. 2' For The low qLalit'V of the regioni's educational instance, it has been argued that the Korean systemii is partially reflected by very high repeti- mniracle" since the mid I 96Ws-where living tion rates, wliclh rank amaong the highiest in the standards have doubled every eleveni years-has developing world. In Bolivia the repetition rate Q U I C K E N I N G T H F P A C E 21 Table 7. Educational Attainment Levels Lat n America and East Asia Comparative Data, 1991 Pormary net Seconoary Tertiary Primary pupil, Country eniollment enrollmenta enrollmentl teacher ratio Argentina na na 43 18 Brazil 88 39 2 23 Ch ie 86 72 2_ 25 Colomb a 73 55 14 30 Mexico 98 55 15 30 Peru na 70 36 28 Costa R ca 8n 4un 28 32 Guatemala na 28 na 34 El Sa vador 70 25 16 44 Jamaica 99 62' 6 37 Trim dad & Tobaqio 91 81 7 26 Latin Amer ca and the Car ibbean 87 47 18 26 Hong Kong na na 18 27 Korea 100 83 40 34 Singapore 100 701 na 26 a. As a pe,centace cf the e ij v e pokulat -,rn Scarce Wcr d Bank WArU Deveeloprr,nl cRoro 1994 goes from 16 percent in Beni to more than 35 that will greatly improve the quality and cover- percent in Chuquisaca. It is estimated that in age of the svstemn, the likelihood of the structural 1990 the cost of repetition exceeded US$4 bil- reforms being sustained in the long run will be lion for the region as a whole. The Eastern greatly reduced. As the experience of the East Caribbean, where a UK-based system operates. Asia miracle countries has shown, a solid educa- has the region's exception.The rate of repetition tional base is required for increasing productivity in those countries is significantly lower tlhani in and successfully competing interniationially. the rest of the region (World Bank 1993).2 Moreover. a broad and high-quality educational Upgrading the quality of education is an system usually provides a ticket for social peace, urgent task. Currently, low-quality public schools harmony and generalized prosperity. coexist with first-rate private schools, creating a dual educational system that tends to perpetuate None of the benefits of all the above inequalities and undermine the bases of democ- reforms will be sustainable in the long run, and racy. Improving the quality of education will several of the incentives implicit in recent require strengthening managemiienit, reallocating reforms will not be effective in stimulating pri- resources, an increase in funding, making teach- vate sector participation, if the judicial system is ers accountable, and more fundamental changes ineffective.The rights and responsibilities of that enhance competition.Teachers should be labor unions and of privately ownied "natural trained using modern techniques. their skills monopolies"; the effective rules of the game should be periodically renewed and their salaries governing foreign investment and land tenure; set according to performance and not on the the threat posed by drug mafias and guerrilla bases of some bureaucratic formula-the best movemenits. All of these issues require a new teachers should get salaries similar to those of approach to governance, in which the role of the relevant comparison groups. Parents should get state can no longer be as a producer of goods more involved in the educational system, by hav- and provider of employmllenit. ing an increasing role in the decislon-miiaking process. If Latin America maintains its traditional neglect for education, and fails to take measures 2') A LONG-TERM GROWTH PROSPECTS A RECENT PROJECTION EXERCISE performled at the World Bank indi- cates that by the end of the century-only five years froma IIow-LAC could be growiing at an annlual rate of 6.3 percent (see Table 8). Broadly speaking, this doubling in the region's average rate of growthi is explained by wlhat we forecast will be important increases in investmiient and advances in factor productivity. According to an IMF study, average ann1ual of 6.1 percent. or close to a full point and a half GDP growth for the 12 largest LAC economiiies mlore thani the LAC countries.I-i duL-inig the 1 5 years betweeni 19701 and 1985 was As we mlenitionied in the previous section, if 2.9. percent.This poor performllanlce was LAC is to achieve higlher rates of growth and if explained primarily by low capital accuLmlulationI that growth is to be sustainiable, the accumtula- (1.5 percent) and very smnall increase in produc- tion of capital and labor has to be complemiienit- tivity ((1.3 percenit). Another World Bank studv ed by several other factors and policies. Of par- recently reached the conclusionl that between ticular importance are the developmlenit of infra- 196(0 and 1987 productivity increased at an structure, the education of the labor force, the annlual rate of only (1.9 percenit. In addition, reduction of policy-induced distortions, the physical capital increased by 6 percent. the labor enhlanicemiienit of international comiipetitiveness, force by 2.9 percent, and human capital by 4.1 anid an overall reduction in the size of the public percent, comlbininig for an average GDP growth sector. rate of 4.8 percent.This picture contrasts sharply It is worth emlphasizing, that these are nec- witlh that of couLntries in East Asia and the essarv elemlenits for growtlh to miaterialize. But Pacific region, which exhibited similar increases they miust also be comlplemiienited by a stable in physical capital (6.4 percent) and in the labor political environment. There is amlple evidence force (2.5 percent), but mLuchi higher advances in that political contflicts deter growvth. The target- productivitv (1.5 percent). As a result, the Asian ing of social expenditure, the reduction in pover- and Pacific regionl grew at an annlLual average rate tv, the redistribution of assets, and compleimieni- Q U I C K E N I N C; T H E P A C E * 23 Table 8. Some Key Determinants of Growth private savings as a percentage of GDP could Ery7-Cs.9905 ProjeCt9onS reach close to 20 percent, compared with the Early!,~g) 1998-221?3 A. Savings 19.9 28.n single digit range in a numiiber of LAC countries PrI.ate 13.8 19.5 today. Public and foreign savings are also expect- Pujoi c 22'_ 6.0 Fore gn 2.9 2.5 ed to develop favorably. B. Investment 19.9 280 Under favorable circumnstances, overall sav- Infrastri-cture 23.0 4. El CIf Schu reing 430 ings should approach 28 percent of GDP, witlh D. TFP grow%th D1 5 private savings complenmented by foreign savings E. GDP gr-o.^;,th 3.4 1 of around 2.5 percent and public savings on the Note Sadinrs arc Investiment are as percEr-,aiges of GDP ScnenO Tri -,,IS S i_ . averaqe years Tctal ma., ntadd on percert daia to rournJinr. order of 6 percent.This would allow for a level a.veae tor TF nowased bo 1 .3 percent oer year !n 13 of gross investmlenit in the neighborhood of 28 and. decreasec rny 1.1 percert per year inr 193-873 Sc,L!rce 'Li,ncl R oLn Pispects yr LAC: Rapiod Gr:orhc s Possil, e,' rirmeo, percent. In terms of growth, the imlpact of LACCE. May 1990 enhan-cing savings and investment by 8 percent- age points of GDP is significant. It wvould raise tary policies that reduce social conflict are, there- the anniual growtth figure by around 2 percentage fore, not just desirable in and of themiiselves but points. are vital componenlts for high and sustainable Factor productivity is also predicted to growth. In that regard, LAC offers some impres- increase as a consequenice of education, deregula- sive grounds for confidence: Betweeni 1993 tion and openness. If results in the region as a when Chile held a presidential and congressionial whole approach those observed in the countries election. and May 1 4 of this year when that pioneered market-oriented refornms, total Argentina did the same, over 85 percent of the factor productivity growth could add 1.5 per- region's population voted in natioinwide elec- centage points to GDP, compared with a negligi- tions. In most of them. presidential candidates ble contributioni throughout the 1980s. supporting economiiic reform were elected or re- By increasing domnestic savings while main- elected. This is significanit evidence for the view taminiig foreign savings at a reasonable and sus- that in the LAC societies there is an increasing taimiable level. and by staying the course on poli- agreement on reform and that there will be a cies that facilitate a more efficient use of high and unprecedented degree of policy conti- resources, LAG wotuld be able to boost its annual nuity in the region looking out to the end of the growth rates from 3 percent to 6 percent.This is, century and, in some cases, beyond it. of course, a preliminiiary estimate that is likely to Returning to the ecoIIomic elemiienits, mianiy be affected by several factors that are very diffi- of the determinlanits of private savings are expect- cult to forecast, such as chaniges in the terms of ed to evolve in a positive direction. On the one trade. Regardless of the preliminary nature of the hand, demographic tendencies suggest that age forecast, it is worth mlenitioniing that early dependency will decline, imlplying an increase in refornmers, both in LAC and in other regionis, the population that will be wvorking and saving. have experienced such GDP increases. The Recent World Bank estimates show that age attainmalent of such rates of growth is not heavily dependency in LAC is 66 percent, as compared dependenit on the ability to attract large amounts to 62 percent in the upper-middle incomle of foreign savings. In fact, the above estimates countries. Moreover, as the LAC countries Conl- assumne a regional current account deficit that is tinue to redefine the role of the state, the private actually smzaller than the one we have seen in provision of certain elemoents of social security is recent years. expected to increase.This will have an additional positive etfect on savings. All things considered, 24 CONCLUSION LATIN AMERICA AND THE CARIBBEAN have the potential to double their average growth rate to 6 percent per year over the next decade. In our view, the response of policvimakers in the LAC regioni to the crisis that began in Mexico in Decemlber 1994 is a very significant indicationi of why that result can be expected. Faced with a forceful negative imiarket reaction to the region as a whole after Mexico's currenicy devaluation, political author- ities, economilc officials anid-more imiiportantly-citizens in the country most affected by the crisis, Argentinla, reaffirmiied their commitlllellt to continue anid to deepen econlomlic reform. Mexico's difficulties were a costly but imlportanit remiinder of the need for urgenicy in Imlovilig to wlhat we have called the second generationi of reformiis. This urgency is a consequenice of two imlportanit to the 3.2 percent that the World Bank considers figures revealed by recenit World Baank studies. the miniiiinurn for producinig an actual reduction The first is that in spite of the economic achieve- in poverty levels. mleints registered in the last few vears, LAC's Moreover, for the reformls that have pro- poverty rates have not budged and incomiie distri- duced the recovery to vield higher growth rates, bution. for wlhich we have no conclusive data, a staggering amounlt of investmiieint is required. niayv have imlproved only slightly. LAC's record is The World Bank's estimlate that $60 billion in nIOW unlbr-okeni: Since the 1 95()s-for four and a infrastructure investmiienit is needed every year half decades-the nuImlber- of people livinig in betweenl nIow and the year 2(0()5 is an indication poverty has not fallen. The imlpressive growth of the order of mnagnitude. For that investmiienit rates reached in SOIme coun1t-ries have barely to nmaterialize-whether private in the case of puslhed the region's average annuall growthi rate infi-astruC-Iture or public in the case of some social Q u I ( k F N T N H - A E P A ( U a 25 services-the second generationi of retorinis mlust secure, both personally anid economically, with be incorporated into the continuinig imacroeco- mlore efficienit systemls of environmiiienital and ionPilc policymiaking agenda. consumller protection, healthl, and justice, and When implemiienited and supported by the witlh fewer fellow citizens living below the inlternatiolnal finlanlcial Comm111unity, including poverty line. the medium- and long-termii multilateral organizationis like our owin, the prospects for sustainied economic growtlh will be reforms of this second phase slhould reach ilnto stronger than ever before. Mexico's difficulties the daily lives of citizens throughout the region. sent a niessage: it has been heard. Because they will be better educated, mlore 26 RECENT EVOLUTION OF i .. . ` D:-.[K . : .. , 4:,:L - ; L!.. >a ! r :. > .ic \ L :. .. .: .. S, .) s- PD . :ri ~ w: i : ;i. C A t : - t.; EaL; ~:;a i: I :i O:- ir d:5d:;( ; 28 L A T I N A M E R I C A A F T E R M E X I C O Table A3. Current Account Balances in Latin America (percentage of GDP) Average Country 1991-93 1991 1992 1993 1994 1995 1996 Argentina -3.1 -1.5 -3.7 4.1 -2.8 -2.3 -2.2 Bo lvia -8.4 6.3 -10.1 -8.8 -5.8 -6.6 -8.5 Brazi 0.3 -0.3 1.5 -0.2 -1.1 1.9 -1.7 Chie -2.1 04 -1.8 -4.8 0.9 -1.4 3.1 Colomb a -5.9 -4.8 -5.5 -I 4 -5.2 4.5 -4.0 Costa Rica 0.9 5 4 1.5 -4.2 -4.2 -3.7 -3.0 Domincan Repubaic -3.5 -2.1 -6.8 -1 5 -1.8 -1.3 -2.0 Ecuador -3.0 -5.0 -0.7 -3.2 -3.1 3.8 -3.7 El Salvador -4.9 5.0 5.8 3.9 -2.9 -1.8 -2.0 Guatema a -5.6 -2.7 -7.6 -6.6 -6.0 -3.3 -3.3 Guyana -23.7 -13.1 -26.3 -31.6 22.0 -22.8 22.2 Ha t -10.4 12.9 -6.9 -11.4 -6.9 -20.6 -17.5 Hondudras 6.9 -5.0 66 -9 2 -8.1 3.7 -3.5 Jama ca -3.1 4.9 -0.1 -4.3 -1.0 2.3 -0.4 Mexico -6.3 -5.i -7.4 6 4 7.7 -0-3 -0.1 N caragua -50.8 48.9 -54.6 -48.9 -48.0 32.0 -34.0 Panama -4.7 -1.9 -5.7 -6.6 5.6 -5.6 -5.5 Paraguay -9.2 8.1 12.4 - 7.2 -5.4 -5 2 -5.2 Peru 5.6 -6.4 -4.6 5.9 -3.1 -3.2 -3.9 Trinidad and Tohago 0.8 0.9 1.7 1.6 2.1 1.9 1.1 Uruguay 1.7 - 1.8 -1 0 -24 2.7 -0.9 -1.1 Venezuela 2.4 2.8 -6.2 -3.7 6.8 5. 7 5.5 a Thesae arge f gures are heavl y aftected bL the ex sternce f toreicon a 1r. Source Jr/cr Bank That situation began to change in 1994. As productivity gains are long term in nature, so that should have been expected, large external deficits no short-term relief should be expected from it. became harder to finance, so that more aggressive Regarding international trade, exports have export strategies and policies to enhance domes- continued to perform quite well, with an increase tic savings were called for.The conditions that in 1994 of 14.3 percent. Imports, however, grew reigned through early 1994 were totally reversed even faster (14.7 percent), contributing to the wvhen the crisis broke in Mexico. Curtailed for- development of large current account deficits.The eign financing is expected to last through most of trade balance followed its negative trend started in 1995. However, once the markets see the emerg- 1991, reaching an $18 billion deficit. Commodities ing economies of LAC rnoving successfully with prices have been evolving favorably in the last the second phase of reforms, foreign capital will couple of years, in sharp contrast with events in return, and this time around direct investment the latter part of the 1980s. According to the will play a more important role.26 World Bank's Global Economttic Prospects, this trend is Figure Al shows the evolution of real expected to continue during 1995 and 1996. exchange rates in the region. It is clear that the generalized process of appreciation observed at Table A4. Net Capital Flows into Latin America pbillions of do ars) the beginning of the 1990s has subsided. The Country 1990 1g99 1992 1993 1994 exception is the Brazilian real, which, introduced Argent na -1.9 3 6 11 2 0 .0 10.5 at a highly depreciated level, has risen by about 30 Braz I 5.3 083 8.8 9.0 13.1 uChile a.J 0.8 3 5 2 8 3.1 percent against the U.S. dollar since the plani's Co mniba 00 -0.8 0.2 2.2 3.1 inception. The external environimient, in which Mexico 8.2 24.9 26.5 30.9 11.5 Peru 0 9 0.5 2.7 2.7 6.0 the region's access to foreign financing has been Venezuela 6.0 1 2 2.5 1.7 5 2 temporarily decreased, requires a renewed attempt LACTotal 14.6 338 61.7 65.1 56.6 at enhaincilng external competitiveness. Increases in IMF f3 199 and lg9l CFPAL fo1992 tc '994. productivity and more competitive real exchange rates will be essential in this respect. However, Q U I C, K E N I N (. T H E P A C E 29 Figure A-1. Real Exchange Rates in Latin America (January 1990=100) Argentina Brazil 200- D 180- --09------------------- i 160)- lI 12C --- ---------------------------------------- 9(- ----t-- ----------- --- ----- m--~~~~~~~~~----- 12 60 - - --- 4-' 1 01^> - - 90Q1 90.,79i 1 9 1 7 92 1 92.93 9:3.7 94.1 94 79.'1 90.1 90 791.1 91 7 31 92. , 73 IJ3. f9 194 7 951 Chile Colombia .2 90 4 15 - /-'-;-\ U F, - - - - - - - - - - - - - - - - - - -9 5- -K--- ---- - doCsaRcaE ao ; 0 - ------------- 85- ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~1 i- --------------- DCh 90.7 91.1 91.7 92 1 927 93 1 93'7 94.1 14.7 9E,. 90 9079' 9 1 91.7 9''1 92.7 93.1 93.7 94.1 94.7 95 1 Costa Rica Ecuador 105-~~~~~~~~~~~~~9 in -c - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 85- 60~~~~~~~~~~- - -- - - - -- - - - -- - - - 90.1I 90. 7 91.1 91 7 92.1 92'7 93 1 93.7 94 1 94.7 93, 1 90~ 1 90.7 911I ('1 I 9 3. 93.1 93 7 34.1 947 95A-.1 Year.month Year.month The inidices were comnputed as RER F P* /1~ where E stands for the nlominial exchange rate in local cuirrenicy units per US dollar, P* represenits the US wholesale price inidex, and P is the local consumer price index. Thus, a decrease in the index represents a real appreciation. Source: IMF, Interniational Financial Statistics 3(1 L A Z I N A N1 F II i A F I F R M L x I () Figure A-1. Real Exchange Rates in Latin America (JarlLary 199'J=1QYJ; El Salvador Guatemala -i 1 - - i F!) 1 11.S'! 1 1 .i2 1, 3 1 :-,- 14 1_ '( {1.1 YV:7 {1 1 01, :i I 97 3±3.1 (.i37:4 1 94.7 935.1 Mexico Peru Il 1 - 1I.) -- ,,~~~~ ~ ~~~ - - - - -- --------- - - - -1 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - I, i , tl-. - <~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ - - - - - - - - - - - - - - - - - - - - - - - - - - ------ S 5 ~~~~~~~~~~~~~~~~~~~~~~~~~~~- - - - - - - - - - I i ., ---------- - - - - - -fr------- *Ao 0iO u7-31 . I til 17 Li 9 . h Y- ' ' 9 1 I r ' ' 7 le4 1 9!4. :l 9%, 1 1t9 Dy-il . 1. i f! ] . ,' 917 2 19'1 7 193714 I 17 7 1 U3ruguay Venezuela ----------------------- ---------- --------------------------- 1 9). < ,- '''1- si 9 9. 1FY SI,3 . 1 71.7 @fl 1 0f--7 93;11 f- 77 .4.1 94.,L. 1 f-)7 147.7 f-131 17 Q71, 92 7 f! l A 0)9-t4 1 9!47 5'.>.1 Ye.ar .rr 'nlt tea, mr - FiSl The indices wvere comlputed as [(ER = EP* /P, wxhere B stands for the nomllinal exchange rate in local currency unlits per UiS dollar, P* represents the US whlolesale price index, and P is the local consumler price index. Thus, a decrease in the index represents a real appreciation. Soulrce: IMF, Internlational Finalncial Statistics 31 NOTES 'LAC region in what follows. 13See the forthcoming World Bank documllent MActiiinv ti/i IWhile large, and even Ncr)' large. Cur rc rt accouLt deficits Iiftriticfitiye Ch§iall .ic in Lnii Amicurica and rl/c Ciri/b)bai. can) take place for a limiiited period of time, they cainnot be 14 Latin America is the oily regioni where the share of inconiie maintained in the loniger run. This is a imatter of arith- going to the poorest 20 percenit consistently dechined mletics. A currenit account deficit ofthre miiagnittide of betwveen 195(1 and the late 197(s. See Sheahan (1987). Mexico's wouild eventually iequire that the country devote 1e Eveii thotigh the Hincidence of poverty-iiieasured as the 100 percenlt of its GNP to pay interest (and dividends) tO proportioin of poor in thle overall popUlation-is gener-allv foreign holders of Mexicani securities, highier in rural areas, the Elet that pOpUlatiOnl expansion is 3See World Bank, TreIds in Deis'/opigii Comtries 1 994, p. heavily concentrated 111 urban areas imiiplies that the 331. nIcrease in the numlilber of poor people is, essentially, an 'Mexico Was sub jected to a nuimilbe- otfserious political uirbani phenomlenon. shocks in 1994, starting with the Zapatist.1 uprisinLg oii 1 World Bank (1992). Janulry 1 the assassination otf Donaldo C'olosio. tile Pll ''Fiszbeini and Psacharopoulos (191)2). presideiti.a canididate, on MNarch 23: the shaky sta.rt 1)) 5Nami (1 94) has otritren rIse pioneer pice Oii this Sub- Eriiesto Zedillo, the neew presidential candidate, in the presidenitial camipaign; aiid the assassination ot Franicisco jt. kuiz Massienl inl SeptemblFer.< 'This is nostlv becaulse retiremlienit schemes are based oin a R ~~~~~~~~~~~~~~~~~defiiied beniefit approacth. xvhiere thlere ik very little COI1- Thre World Bank has recenitiv coniiitted two loans to the slection1 (it-f' 1) between \vorkers' contributions and the Argentinie Republic for a total of US$1.)) billiol to hielp privatize provincial hanks and restructire the banking sys- tem. lIn addition, it has coisinitted two loans for US$31))° 'T\.V SC hultz (1961. 1978) has beein the indisputable iilillionl to help strengthen thLe provision of social services modern pionieer of this view in economics. See also (healthl ilIsuranice and1 a social safetv net) duLr1ing the adjtist- Hlarberger (1959) and Psacharopoulos (1)92). milent process. Cinosta Rica was the exception. whvhere second tier schools 'This section draws partially oni Blirki and Edwards had very stroiig test scores. (19 95). "It should be nioted that high repetitioni rates reflect a Ilinple,lil(riioiT tilQhe l~lbdrd Bank is Swtegz)' to> Red lewt' iN',ert}': lly riad of'factors It Is nsot neot ear Sly trtle t hIt 3 loW level Pro)gress and Chal/oiuL(rS, April 1 9930 of repetit)on) reflects highl CdLtica)oii.l standards. In fact tle 'See C .P.AL \cw~,-The Pro-rc~s ofl-,itm Americall and Ideal sltu.ation) is one where rates of repetitioni are lov i 5See CLI e'i,"Te rores f atn iierai 1 standardized results are hi-l. Caribbeai Integration ' April 19')5. 1tSee CEPAL (1994). Repor 1 gorio ( nd llrll Bak Doclpmit WIWI[r 1(95 1'For a thorougIl analysis ot savinigs 1 i developinig coini- '5ee Edws (19) tries,see Edwrards (1995). tre,seE\. a-s( 9) I f11lrild DcuclwlevE!opm R(-port, I 919 to e publ){{i;e/iL(d. It is interesting to nlotice that during the second half of the 198')s the level of finrancial depth in the region-nica- In I 995 t lregioiis etirreiit aceotiur deficit is expected sured by the ratio of money to (I)P-xvas .iliiost one half' to be close to .8 percenit of (DiA down fnroim abotit 3 of' what it was in the i'est oftthre orld. pberceiit in 1993-94 (see%World Bank. Global Ecioluiui 'Strictlvy speaking, what m]atters is the rclation betwven Proensc conitributionis and expected benefits. If the retireisiciit sys- temii is benefit-defined--as maim' Latin American systems are--it will tenid to discotirage private saviIgs. 32 REFERENCES Br rki, S/ihahidj J. and Seba stiai r Edirlvrds (I 995). Ca baliolidtin I h(anz Macr ioccon rmicr Shocrks to Ihistitiariail ThI/erapy, Sarl Economic RelOrMs in Latin --I irica on] li/t Caribhean,' Franicisco O)ccasional Paper Nor. 62 International Finianicc and 1e)velopmnent March. Center for Econonilic Growt'h. (CEI'AL (1')994). I--l Ks5Rjsl;eip ari2Ar ir-to Il oi Airita l1,itiia y Psaclhiarra)0.u0los. Creorge (1'9)2). Pov'ertry aid hicome ri Caribc. Santiago, Comiisi6n Econ6imica Par-a D)istriblmtimn in Latii A ni'rica and tice Caribb,ean Anr3rica Latin.a v el Caribe. WailhirLgton, I:)C., The \W,"orld Baik. Latin Amilerica I)e Cw regoCrio, Jos9 (1991). LEinomini (,tro,/i in, Litini -mcricr, aMid the C a ribberdl l.Cgioll. INiF \Vorking Paper, WI),"') 1/7 71. Wahi mgton, D.C. Schultz.mThlodore W (I1(91). "Iiovestiorenit in Human Edwards. Sebastian (1993). Ltri7b A drrncr a Decade .Ater tihe Capital:' Armrericarr Ewarrrirmic Re'ierr', Vol. 51. March. Debr Crisis, Wiashlingiton. I).C., The World Banik. ScIhltz. Theodore W (197X)."Nobel Prize Address." Ot)ifce of theVice Presiderit. Latirr Ar irricr arid the /t111irnal al Political Ecearlry, Vol )8(. I )ecimber. Caribbeanil. Sir cA lia Jllobr (I )X7). ritterris a L) 'elpmjirrreit in Latin) E dwa rds. Sebas tian (9 5) . -W Ihv are L atin Amirer i ca's A r enica Par -ert y, R(ePR'essiar, ard Ecal l mir .rue Strar ( Saving Rates so Low? Ani Initerratiorral Coirrparative New Jersey. lrincctoni Universitv Plress. Arvsi*'' NBER \iOrkirg Pappe- No. S ))7. \XVorrId Barik ( 1995). Global Eooi torei/- P'5;reet crv iid tile Camiibridge, MA. /apirii., Car, rnes, Wisi r gtorr, I). C Fiszbeiri, Ariel arid George Psacirarlporlos (1 992). \World Bank (1994).."The LAC IntfratrntFctUre Ilritiative,r Inlicomeir I rreqUalityTrends in Latin America rIn the rriirleo. W\ashilngtol. I).C. I (9 (Is: A D)ecominposi tioni Ai.alvsis,' paper pi-ersi ted \World Bar ik (1 993) Implrrlnerrtir ir tire I Vbrid Barrlk Stratc:e)i to at the Conferceice oni Povertv .od Iireq.ialitv ir Redu icc' lPovierty: ProiQrcs ai C/1 ( lter IWsh. X'inirigton. Ilatill Anierica, Brookirgs Ilrstitirtioi,\ Wrlsiiigtori. I).C., The World Banik I ).C.. JIilv. World Barik (1994). 'Ihcrds i,r DcvcIopi,ir Lctarormries, Harbergcr.Arrio Id (93).i "UUilr tiIC Re.esources at Ha,rrd WNshirrgtorn. DC-The World Bank. Miore Etfiiriclevb," Am- ririic.rii Feart ra c r i cic, Vol. 49, WVorld B anuk. I -brrid Der ctopmcw; i r Report. New York. ()xford Jure. Utrvcrirty [Prcss, several issues. Naiii. Moisrs (I919)4). Lrtiir .mcmieri4 Jaiirii ) to trec MA rrkct: Other titles from the World Bank Edwards, Sebastian. Crisis and Reform in Latin America: From Despair to Hope. Published for the World Bank by Oxford University Press. 1995 Grosh, Margaret E. Administering Targeted Social Programs in Latin America: From Platitudes to Practice. World Bank Regional and Sectoral Studies. 1994. Investing in People: The World Bank in Action. Directions in Development Series. 1995. Also available in Spanish. Psacharopoulos, George, and Harry Patrinos. Indigenous People and Poverty in Latin America: An Empirical Analysis. World Bank Regional and Sectoral Studies. 1994. Psacharopoulos, George, and Zafifis Tzannatos. Women's Employment and Pay itn Latin America: Overview and Methodology. World Bank Regional and Sectoral Studies. 1992. Priorities and Strategies for Education: A World Bank Review. Development in Practice Series. 1995. Also available in Spanish. Serven, Luis, and Andres Solimano. Strivingfor Growth after Adjustment: The Role of Capital Formation. World Bank Regional and Sectoral Studies. 1993. Toward Gender Equality: The Role of Public Policy. Development in Practice Series. 1995. Van der Gaag, Jacques. Private and Public Initiatives: Working Together for Health and Education. Directions in Development Series. 1995. World Development Report 1990: Poverty. Published for the World Bank by Oxford Univeristy Press. 1990. Also available in Spanish. Young, Mary Eming. Early Child Development: Investing in the Future. Directions in Development Series. 1996. e Z . i !> . aS. I 4 , l r b~~*S I L S] _ ~~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~ S - I ~~~~~~~~~~~~* I S! iS S _ : e !w1 T - 5 L D . *. I' . ,e. . _ ~ ~~~~~~~~ S ,xIIIi#Z,,,,,.. _!~~~~~ . . II ..... .ii. it,~~~~~~~~~~~~~~~~~ '8?11 3a 629