Latin America: Between Populism and ModernitySpeech by Rodrigo de Rato,
Managing Director of the International Monetary Fund
At the International Foundation for Liberty Conference
Cato Institute, Washington DC
November 30, 2006
As Prepared for Delivery
"Economic Policy in Latin America:
Addressing Inequality While Promoting Growth"
1. Thank you very much. It is a pleasure to be with you again. I would like to talk today about economic policy in Latin America. But I cannot speak at the Cato Institute without first saying a few words about Milton Friedman, who died on November 16th.
2. Milton Friedman had an extraordinary capacity to change people's minds. Many of us who have been involved in economics or politics over the past 50 years have had a long-held, comfortable belief suddenly overturned by an argument from Milton Friedman. He could make a case that was so compelling, so obviously right, that people wondered why they ever thought any other way. For some economists, it was Friedman's restatement of the quantity theory of money, an insight that still informs the thinking of central banks all over the world and the financial programming model of the IMF. For others, it was his dissection of the Philips curve. Others have been reawakened by his work to the virtues of floating exchange rates, or the role of expectations of future income in shaping consumption. Few people agree with all of Milton Friedman's views, but almost everyone has learned from him. His life and work exemplify reason applied in the service of liberty. The Cato Institute is a fitting place to pay him tribute, and I am glad to do so.
3. Let me now move on to the main subject of my remarks today, beginning with a simple statement of fact: most countries in Latin America are doing better than they have done for many years. The region is enjoying a period of solid growth and low inflation. In both 2006 and 2007, we expect real growth to be more than 4 percent, making the current expansion the most vigorous three-year period of growth since the 1970s. Regional inflation has also declined during this period of growth. Average inflation has come down in the last two years, and we expect a further slight fall, to just over 5 percent in 2007. The regional economy has been boosted by high prices for the commodities it exports, good global financial market conditions, and strong growth in its trading partners. But its success also owes much to sound policies. Fiscal and external positions are much stronger than in earlier expansions; more countries have flexible exchange regimes that help them to absorb shocks; and around the region, central banks have established credibility in combating inflation. This credibility enables them to set lower real interest rates, which support growth.
4. Despite this solid progress, in a number of countries in Latin America, there is dissatisfaction with the outcomes produced by these policies, especially the distribution of economic power and wealth. In some cases, the policies themselves are questioned. I presume that it is these questions which give rise to the subject of this conference—the presumed opposition of "populism" and "modernity." I will suggest that pursuing policies that promote stability and growth and also addressing concerns about distribution can and should go hand in hand. One obvious way that this is true concerns inflation. There is now a general recognition that inflation is much more harmful to the poor than to the rich, because the rich are much better equipped to hedge against it. So policies that reduce inflation benefit the poor. Similarly, policies to contain public debt are also important, as the costs of dealing with excessive public debt often fall heavily on the poor.
5. Let me now talk about some specific policies. I will begin with policies focused primarily on stability, then discuss policies designed to increase growth, and continue with policies designed to reduce inequality and poverty. But I would emphasize that these polices are mutually reinforcing.
6. I will begin with fiscal policy. A commitment to sound public finances and success in bringing budgets under control have been among the major achievements of the past decade in Latin America. But in a number of countries, government spending has increased recently in a way that is disturbingly similar to previous expansions. For the sake of macroeconomic stability and to avoid crowding out private sector credit, spending should be restrained. This is not to say that spending increases are never justified. In fact, effective spending on infrastructure, on education, and on the social safety net is very important. But governments should keep in mind the need to avoid painful reversals, and should look to reallocate spending from less productive programs before they increase overall spending levels. It is also important to reduce overall debt levels. Public debt in the region has fallen to about 50 percent of GDP this year, from highs of about 65 percent of GDP in 2002. But the debt level is still as high as it was in 1999-2000—the years immediately preceding the crises in Latin America. Reducing public debt would also give governments more room to follow a counter-cyclical fiscal policy in the event of an economic slowdown.
7. It is also important that budgets be made more flexible in many countries. Today, too much expenditure is mandatory; too much revenue is earmarked for specific purposes. And while overall revenue levels are not out of line with the rest of the world, there is a need to broaden tax bases in many countries. Eliminating tax exemptions and improving tax administration, rather than increasing tax rates, should be the priority.
8. Fiscal policies can also promote growth. For example, within government budgets there is scope to reallocate spending toward capital expenditure. Capital spending has fallen as a proportion of total government spending in Latin American countries. More investment of high efficiency will be needed in order for the region to raise potential growth and to compete with other dynamic emerging markets.
9. Moving beyond fiscal policy, there are a number of structural reforms which governments can pursue that will promote growth. Improving the level of skills and education in the region would obviously help. So would policies that increase openness to trade and competition. For example, many countries could benefit from efforts to lower barriers to entry and the cost of doing business, improve regulatory frameworks, attract foreign direct investment, and reduce barriers to trade in services.
10. Let me amplify on the last point a little. One of the greatest sources of global growth in recent years has been increased freedom of trade, achieved in particular through multilateral trade reform. For this reason, governments and citizens all around the world, including in Latin America, should be very concerned about the lack of progress in the Doha Round. A failure of multilateral trade talks would be particularly damaging to Latin America, because Latin American countries have much to gain from liberalization of agricultural trade, and this is not likely to be secured in bilateral or regional agreements. More generally, if there is an upsurge in protectionism, the whole world will suffer, and Latin America's prospects will be stunted. There is a consensus among the major multilateral organizations, as Paul Wolfowitz and I said at the G-20 meetings in Melbourne, that a substantive agreement is important, that it is the best possible stimulus that one could give the global economy at this time, and that failure would carry a high cost for all and especially the poorer countries. I hope that each of the major players—including Latin American countries—will take the steps necessary to break the deadlock. A "you first" approach will not succeed.
11. Let me now turn to issues of inequality and poverty. It is obviously important that the benefits of stability and growth are shared widely and, in particular, reach the poorest people. I believe that the lack of progress in this area is one of the main reasons why policies that promote stability and growth are questioned in some countries. Growth has not been strong enough to make a sufficient impact on poverty. And its benefits have not been widespread enough to make a sufficient impact on inequality. For the sake of social equity and to preserve a consensus around reform, governments in Latin America must tackle poverty and inequality.
12. The most effective way to do this would be to pursue policies that re-allocate spending toward pro-poor programs and away from some of the outlays that heavily benefit middle- and upper-income groups. Let me give a few examples:
Non-targeted subsidies for petroleum products and electricity could be replaced with targeted social assistance.
In education, cost recovery could be increased at the tertiary level, where it largely benefits upper-income groups. The proceeds could then be used to strengthen the quality of secondary education, especially in rural areas.
Public pension systems—which also mostly reward upper-income groups—could be reformed further.
And governments could devote more resources to targeted social assistance programs such as Oportunidades in Mexico, Bolsa Familia in Brazil, and Chile Solidario in Chile. These have been highly beneficial to the poor, but their effect on income distribution has been limited by their modest size relative to other government spending.
13. There is also scope for action on the revenue side. For example, we support the initiative that a number of countries have taken recently to introduce taxes that will be paid mostly by those with the greatest capacity to pay—especially taxes on vehicles, other property, and financial income. Elimination of tax exemptions would also help, as exemptions at present often benefit high earners and relatively wealthy consumers.
14. Even more fundamentally, governments should take steps to promote equality of opportunity. These include better educational opportunities, but also broadened access to credit and financial services, which many of the poor do not have. They could also include labor market reform, recognizing that most of the poor in Latin America are outside the formal system of employment, and thus do not enjoy legal benefits or protections. Measures which liberalize employment law and which also have the effect of bringing more workers into the formal sector would thus promote equality and help to reduce poverty.
15. I want to emphasize that many reforms that would promote greater equality—such as labor market reform—would also promote stability and growth. And, as I have already said, many reforms that promote stability would also promote greater equality. For example, less rigid budgets would enable governments to respond flexibly to those most severely affected by downturns.
16. Before concluding, let me say a few words about how the Fund should respond to the questions that I have talked about. One element of our response must be pragmatism. The Fund should not refrain from telling governments what we think, and from continuing to emphasize the virtues of policies that promote stability, growth, and openness. And we must also take seriously the policy priorities of governments, and be prepared to work with them to help them achieve their aims and benefit their people.
17. In a broader sense, the Fund and the wider international community face a challenge similar to that faced by governments in Latin America. The world is experiencing a wave of economic and financial globalization which has many benefits. But not everyone is enjoying those benefits. We need to come up with a response to those who have lost out from globalization and to those it has not yet reached.
18. A good part of the work we are doing in the Medium-Term Strategy of the IMF, which is our plan to reform the institution, is designed to meet this goal. We are refining our work on low-income countries, to ensure that we are focused on issues where we can make the greatest contribution to help these countries raise growth and reduce poverty. We are examining the tools we have to combat financial crises, which have been so damaging to Latin American economies in the past. We are sharpening our surveillance of individual countries and the global economy to spot problems early and help our members to head them off. And we are reforming the Fund's governance structure to ensure that our voting shares better reflect the increased importance of emerging markets in the global economy. In doing so we are also seeking to protect the voting shares of low-income countries, many of which have yet to experience the increased prosperity that globalization can bring.
19. This is a good time for both the Fund and our members' governments to tackle long-standing problems and to prepare for new problems that may emerge. The global economy is currently strong, and financial market conditions benign. In Latin America, great progress has been made in stabilization, and growth prospects are good. Now is the time to take actions which will sustain high growth and broaden its benefits. We should not lose this opportunity.
20. Let me conclude by returning to what I said about Milton Friedman. He was a champion of reason in the service of liberty. We too must deploy reason in the service of liberty, but we must also give due attention to alleviating inequality and poverty. My central point is that policies that support stability and growth can also be designed to reduce inequality, and raise people out of poverty. Such policies would benefit all of the people of Latin America.
21. Thank you very much.