LATIN AMERICA: IS IT MOVING FORWARD? Ricardo Hausmann Kennedy School of Government Harvard University

LATIN AMERICA: IS IT MOVING FORWARD? Ricardo Hausmann Kennedy School of Government Harvard University

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

Latin America recovered in the 1990s 6 5 4 GDP Growth porcentaje 3 2 1 0 1965-70 1971-80 1981-90 1991-98 Fuente: IDB

Based on significant structural reform Avance de las políticas estructurales 80% Trade Variación relativo al máximo 60% 40% 20% Financial 0% Fuente: Lora, 1997

that is still incomplete by area Avance de las políticas estructurales 80% Trade Variación relativo al máximo 60% 40% 20% 0% Financial Tax Privatization Labor Fuente: Lora, 1997

Cambios en Tasas de Crecimiento 15% 10% 5% 0% More reforms, more growth Cambios en Crecimiento y en Políticas Estructurales (1993-95 vs. 1987-89) Brazil Nicaragua El Salvador Trinidad and Tobago Argentina Colombia Guatemala Bolivia Ecuador Costa Rica Uruguay Venezuela Chile Paraguay República Dominicana Honduras Mexico Perú Jamaica -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% Cambios en Indices de Política Fuente: Lora y Barrera, 1997

1997 was a very good year 6.0 Real GDP Growth (Average 8 Largest Economies) 6.0 5.0 5.0 percent 4.0 3.0 4.0 3.0 2.0 2.0 1.0 1.0 0.0 90 91 92 93 94 95 96 97 0.0

but then came a bad streak Asian Financial crisis Collapse in the terms of trade El Niño Russian crisis and contagion Hurricanes Georges and Mitch Brazilian crisis

The collapse in the terms of trade 125 Commodity Prices 115 105 Copper 95 85 Wheat 75 65 Oil 55 45 Thailand Hong Kong Russia 35 1/2/97 2/2/97 3/2/97 4/2/97 5/2/97 6/2/97 7/2/97 8/2/97 9/2/97 10/2/97 11/2/97 12/2/97 1/2/98 2/2/98 3/2/98 4/2/98 5/2/98 6/2/98 7/2/98 8/2/98 9/2/98 10/2/98 11/2/98 12/2/98 1/2/99 Index 01/02/97 = 100

Major financial shocks and recovery Latin Eurobond Index Spread (1994-98) 1,700 1,500 (Mexico) 1,700 1,500 1,300 1,300 1,100 (Russia) 1,100 900 900 700 700 500 (Hong Kong) 500 300 300 100 3-Oct-94 3-Dec-94 3-Feb-95 3-Apr-95 3-Jun-95 3-Aug-95 3-Oct-95 3-Dec-95 3-Feb-96 3-Apr-96 3-Jun-96 3-Aug-96 3-Oct-96 3-Dec-96 3-Feb-97 3-Apr-97 3-Jun-97 3-Aug-97 3-Oct-97 3-Dec-97 3-Feb-98 3-Apr-98 3-Jun-98 3-Aug-98 3-Oct-98 3-Dec-98 100 Source: JP Morgan.

Private capital inflows collapsed Capital Flows 100 95 90 85 80 75 70 65 60 55 50 45 40 Net Capital Inflows and Commodity Prices 1991 1992 1993 1994 1995 1996 1997 1998 1999 130 125 120 115 110 105 100 95 90 85 Non-fuel commodity prices

when they were most needed Capital Flows 100 95 90 85 80 75 70 65 60 55 50 45 40 Net Capital Inflows and Commodity Prices 1991 1992 1993 1994 1995 1996 1997 1998 1999 130 125 120 115 110 105 100 95 90 85 Non-fuel commodity prices

only marginally offset by official financing... 90 80 70 60 50 40 30 20 10 0-10 -20 1997 1998 1999 Private Net Flows Official Inflows Acum of Reserves CAD

causing a collapse in imports 160 Trade and Current Account (excl. Mexico) 140 120 100 80 60 40 20 0. -20 1991 1992 1993 1994 1995 1996 1997 1998 1999-40 -60-80 Exports(-Mex) Imports(-Mex) Trade Balance(-Mex) CA(-Mex)

that exceeded the fall in exports 35 25 15 5 Exports Imports Comparing Recessions (absolute change between periods) Trade Balance -5-15 -25-35 Source: WEO 1994-1995 1997-1999

and caused a collapse in growth Real Growth in Latin America 6 5 4 3 2 1 0 Source: WEO 1991 1992 1993 1994 1995 1996 1997 1998 1999

Venezuela Argentina Ecuador Chile Guyana Peru Western Hemisphere Uruguay Mexico Brazil Colombia Suriname El Salvador Dominican Rep. Belize Bahamas Panama Grenada Honduras Paraguay Trinidad&Tob Guatemala Dominica Nicaragua Bolivia Barbados Haiti Jamaica Costa Rica that affected most countries Fall in Growth (Average 1999-98 vs 1997) -2 0 2 4 6 8 10

Latin America: no Fireworks Since the East Asian crisis No systemic banking crises No widespread currency crises No inflationary crises No debt crisis No reversal of reforms

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

Capital flows have been recovering 4.0 3.5 3.0 Figure 12a: Net Private Capital Inflows, Portfolio, FDI and Loans in Latin America, 1996-2000 Private Capital Inflows 2.5 2.0 FDI 1.5 1.0 Portfolio 0.5 0.0-0.5 1996 1997 1998 1999 Loans 2000-1.0 Note: As percentage of GDP. Source: Balance of Payments, IMF.

Commodity prices have stopped 120 falling Commodity Indexes (Index Jan 97=100) 110 100 90 80 Agricultural 70 60 50 40 Energy 30 01/01/97 01/31/97 03/04/97 04/03/97 05/05/97 06/04/97 07/04/97 08/05/97 09/04/97 10/06/97 11/05/97 12/05/97 01/06/98 02/05/98 03/09/98 04/08/98 05/08/98 06/09/98 07/09/98 08/10/98 09/09/98 10/09/98 11/10/98 12/10/98 01/11/99 02/10/99 03/12/99 04/13/99 05/13/99 06/14/99 07/14/99 08/13/99 09/14/99 10/14/99 11/15/99 12/15/99 01/14/00 02/15/00 03/16/00 04/17/00 05/17/00 Source: Goldman Sahcs Commodity Indexes

World outlook looks good Continued recovery in Europe and in East Asia mild recovery in Japan and a roaring US economy

and the region is expected to 6 recover Real Growth in Latin America Annual percent change 5 % 4 3 2 1 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Source: WEO

What will the future bring? Are we facing another boom? Will it be followed by another crisis? or will it be sustained?

Four scenarios ahead Dangerous Safe Deep Boom - Crisis High, sustained flows Shalow Mild boomcrisis No boomno crisis

The origin of crises: the mainstream approach Booms and crises were caused by moral hazard and an inadequate perception of risks

Mainstream View #1 Large recent losses Shallow and safe and changes to international financial architecture: lower bail-outs, more bail-ins more flexible exchange rates will reduce moral hazard, giving rise to a more moderate but sustainable scenario.

Mainstream View # 2 Deep and dangerous Booms and crises are caused by moral hazard...but nothing substantial has changed so we will get another boom, followed by another crisis

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

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

View # 3 Shallow and dangerous Countries do not deal with the mismatches Risks are perceived as high, Flows will be low...but still a crisis. Deep and dangerous also a possibility if the market focuses on the good equilibrium

View #4 Deep and Safe Countries deal with the mismatches: developing the ability to borrow internationally in their own currency adopting common currency that does not have original sin. The market can support large, sustainable flows

FDI has been booming 80000 FDI Flows 1990-1999 70000 60000 Millions US$ 50000 40000 30000 M&A,privatization New FDI 20000 10000 Source: ECLAC 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999a

but in the context of declining total flows Net Commercial Capital Flows and Its Composition for Latin America 120 1.2 US$ Billions 100 80 60 Net Commercial Flows FDI / Total Flows (%) FDI 1 0.8 0.6 Percentage 40 0.4 20 0.2 0 Source: IIF 1996 1997 1998 1999 0

Is FDI like good cholesterol?

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

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

More development, more foreign capital 60% Foreign Capital Stock and Income Developed 50% Foreign Capital Stock / GDP 40% 30% 20% 10% 0% Africa Asia East Asia East Europe LATIN AMERICA -10% 2.5 3.0 3.5 4.0 4.5 GDP per capita (log) *Data refers to stocks of 1997 in current dollars and GDP in PPP current dollars. The GDP per capita is a weighted average of countries for the same year. Source: IFS, WB and RES-IDB.

but a smaller FDI share 100% Composition of Foreign Capital Stock and Income Africa FDI / Total Capital Flows 80% 60% 40% 20% Asia East Asia East Europe LATIN AMERICA Developed 0% 2.5 3.0 3.5 4.0 4.5 GDP per capita (log) *Data refers to stocks of 1997 in current dollars and GDP in PPP current dollars. The GDP per capita is a weighted average of countries for the same year. Source: IFS, WB and RES-IDB.

FDI/GDP: Outcome of opposite 8% 7% 6% forces FDI Stock and Income LATIN AMERICA East Asia Developed FDI/GDP 5% 4% East Europe 3% Africa Asia 2% 2.5 3.0 3.5 4.0 4.5 GDP per capita (log) *Data refers to stocks of 1997 in current dollars and GDP in PPP current dollars. The GDP per capita is a weighted average of countries for the same year. Source: IFS, WB and RES-IDB.

Richer, larger, more open economies don t have higher FDI-shares Correlations with Volume and Composition of Capital Flows 0.8 0.6 Volume 0.4 0.2 FDI/GDP 0.0-0.2-0.4-0.6 Composition Income Size Openness

Riskier countries get less capital, but a larger share of FDI Correlations with Volume and Composition of Capital Flows 0.6 Composition 0.4 0.2 0.0 FDI/GDP -0.2 Volume -0.4-0.6 Country Risk

Resource rich, distant countries don t get more capital, but higher FDI-share Correlations with Volume and Composition of Capital Flows 0.6 0.4 Composition 0.2 FDI/GDP 0.0-0.2-0.4 Volume -0.6 Subsoil Resources Distance

Better finance, better institutions don t 0.8 beget more FDI-share Correlations with Volume and Composition of Capital Flows 0.6 Volume 0.4 FDI/GDP 0.2 0.0-0.2-0.4-0.6 Composition Financial Development Quality of Institutions

Original sin increases FDI-share Correlations with Volume and Composition of Capital Flows 0.4 Composition 0.2 0.0 Volume FDI/GDP -0.2-0.4 Original Sin

Good things are associated with more foreign capital inflows but a lower share of FDI Controlling for income, size and openness, lower risk and better institutions do not increase the share of FDI

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

Looking into the more distant future

Structural reforms are continuing Bank Supervision Pensions Funds Capital Market Privatiz. & Regulations Comercial(X,M) Foreign Investment Education Tax Sistem Justice Labor Property Rights Health 0 0.2 0.4 0.6 0.8 1 1.2 Source: Survey. Note: Difference with respect to 3 years ago (based on scale 0-5)

Latin America has a Demographic Window of Opportunity 1.6 Adjusted dependency ratio Adjusted dependency ratio 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 Window of opportunity 0.7 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 Source: Duryea and Székely (1998)

What does demographic More work opportunity imply? More savings More education THE OPPORTUNITY TO BE THE FASTEST GROWING REGION IN THE WORLD