Chile and the IMF
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Managing Director of the International Monetary Fund
at the Europe-Latin America Convention
Bordeaux, France, October 20, 1997
Latin America has long been characterized as a region of enormous economic promise thanks to its abundant natural resources, substantial industrial base, and potentially vast internal market. But in decades past, these complimentary words were often just the preamble to a long lament about poor management and lost opportunities. Latin America has changed a great deal since those days. From my vantage point at the IMF, I can say that Latin America is now a region on the move, a region that is at last beginning to fulfill its vast economic potential, a region that is consequently full of new promise and possibilities. In my remarks to you this morning, I would like to sketch out how I see the situation evolving in that vast continent and discuss the challenges it faces in this new era of globalization.
Each time I travel to Latin America—and during more than ten years at the IMF, I have made countless trips there—I am amazed by how much attitudes and policies have changed and economic performance has improved. A decade ago, few countries, with the notable exception of Chile and Bolivia, had adopted a comprehensive approach to economic reform. During the 1970s and early 1980s, there had been sporadic attempts to achieve macroeconomic recovery, but the underlying structural causes of high inflation, weak balance of payments, and anemic growth had been left largely unaddressed. To be sure, there were a growing number of policymakers who recognized the need to take a more comprehensive approach. But it took time to develop the consensus to do so. In the meantime, bitter doctrinal battles were waged over such issues as the need for fiscal and monetary discipline, the appropriate roles of the state and the private sector, the merits of economic liberalization, and the virtues of deregulation.
Today, these old battles are by and large a distant memory. Since the late 1980s, most countries in the region have drawn the lessons of past policy experiments and their disappointing and sometimes catastrophic economic and social consequences. Thus, they have found cooperative solutions to their debt problems and turned to other objectives: achieving macroeconomic stability, making their economies more modern and efficient by promoting domestic competition, trade liberalization, privatization, and foreign investment, and decisively integrating themselves into the global economy.
The results of this policy shift have been remarkable. Average growth in Latin America and the Caribbean rose from less than 1 ½ percent in 1988-89 to 5 percent in 1994, the highest rate since 1980. And although the economies of the region were not immune to the "Tequila effect" associated with the Mexican crisis, growth is now once again close to 5 percent for the region as a whole. Meanwhile, average inflation in the region has fallen from a breathtaking 1,100 percent in 1989 to an expected 13 percent at the end of this year—on average still too high, but a major improvement. Private capital inflows have increased from close to zero in 1989 to over US$70 billion last year—3.5 percent of the region’s GDP—and the gross international reserves of the region as a whole have increased fivefold over the same period. In short, the countries of Latin America and the Caribbean are generally performing better than at any time in the past twenty years. Against this general background, there have been some outstanding achievements in the last few years. Mexico’s rapid recovery from the 1994-95 crisis, Argentina’s success with its currency board arrangement, and Brazil’s accomplishments under the Real Plan come immediately to mind. And, of course, in many ways, Chile continues to show the way for the continent.
But enough praise. If I were to give a full account of Latin America’s success story, we would be here long into the night. So let me turn instead to where I see the challenges for the region. In my view, there are two sets of issues that need to be tackled head on.
The first concerns public frustration over widespread poverty, income inequality, and the generally slow pace of social progress. Despite the recovery in recent years, inequality remains pronounced, and it is estimated that more than one third of all households, or more than 200 million people, continue to live in poverty. Of course, there are some exceptions—poverty is less prevalent in the countries of the southern cone, and Chile is making a measurable dent in poverty levels. But the overall picture of growth and social progress in Latin America over the last 30 years is clearly less than satisfactory.
The second challenge has to do with the need to equip these economies to maintain their access to the international capital market and weather changing conditions in global markets. The recent crisis in Thailand and its contagion to other southeast Asian economies show once again how quickly market sentiment can shift and how costly a loss of market confidence can be. Latin America has not been affected by these developments, nor would the policies now in place suggest that such developments would be replicated in the region. Still, the experience in southeast Asia is a call to vigilance for every country that taps, or hopes to tap, the international capital market.
At first glance, these two challenges may seem worlds apart—as distant from one another as the villages of the altiplano or the favelas of Rio de Janeiro are from the office towers in Buenos Aires or Sao Paulo. But on closer inspection, these issues are more closely related than first meets the eye.
High but sustainable growth is a precondition for achieving a decisive and lasting improvement in economic opportunities and social conditions in Latin America. And the availability of private foreign capital can help increase investment, create new jobs, and thereby accelerate economic growth and social progress. But sustained growth and capital inflows require sound macroeconomic policies and continuing decisive structural reforms to improve the investment climate and allow markets to work better—all of which may be called into question unless the fruits of economic success are more equitably shared. Moreover, when market confidence is lost, it is the poor and the disadvantaged who suffer most from the ensuing economic disruption. I would also add that low levels of education and health associated with the rise in poverty dampen productivity and growth and discourage investment. For all of these reasons, the challenges of combating poverty and income inequality and of maintaining market confidence are linked.
What then should countries do to meet these two challenges? The only feasible policy course—and, indeed, the approach being taken in the programs supported by the IMF, the World Bank, and the Inter-American Development Bank—is, first, to continue with the stabilization policies and reforms that have contributed most to the improved investment climate and stronger growth of the 1990s; and second, to decide what to do to ensure that the benefits of this stronger growth are more widely and equitably shared. This latter set of reforms is what has been referred to as the "second generation" of reform. As you will see, many of the reforms that would be most effective in making economic opportunities more widely available throughout that continent, and thus in overcoming the problems of poverty and income inequality, are also the reforms that will also make these economies more competitive, more resilient, more attractive to foreign capital, and better able to cope with global market forces. Let me elaborate.
The second generation of reform
The crux of the "second generation" of reform has to do with completing the transformation of the role of the State. During the late 1980s and the early 1990s, Latin America made considerable progress on what might be termed "first generation" reforms that reduced the public sector’s role in productive activities that could be better performed by the private sector and gave market forces the necessary leading role in allocating domestic resources. Now, to complete this reform process, countries need to move from "less State" to "better State." Herein lie the tasks for the second generation of reform: developing efficient, accountable government institutions that will guarantee the rule of law and support private sector initiative and activity; and providing the infrastructure and public services that the State is best placed to provide.
Of course, one cannot draw a sharp distinction between these two generations of reform. Many countries have already begun to take measures associated with the second generation of reform, even though the reform programs associated with the first generation have yet to be fully completed. But I see at least four tasks that must be on the agenda for the second generation of reform in Latin America.
The first task is to enforce the rule of law and uphold the professionalism and independence of the judicial system—ensuring that there is prompt and equal justice for all, and giving confidence to all members of society that contracts will be enforced, rights will be protected, and property will be secure. Supporting measures are needed to increase the capacity of the court system, increase the professionalism of the police, and improve civil administration. For the economy to function smoothly, for the government and its reform program to retain credibility and support, the system must give confidence that justice will be done.
The second task is to work energetically toward establishing simpler, more transparent regulatory systems that are equitably enforced—systems that ensure equal access to markets and thus promote equality of economic opportunity; systems that encourage competition, eliminate unnecessary business costs and, thus, promote efficiency and growth.
One crucial aspect of the regulatory environment concerns the effectiveness of prudential regulation and supervision in the banking sector. Certainly, Latin American governments are well aware of the importance of this issue, but developments in Thailand and Indonesia, where growing doubts about the soundness of the banking system contributed to the loss of market confidence, have refocussed attention on this issue. In this regard, even countries well advanced in the bank restructuring process would have much to gain from increasing the transparency of the financial sector. In particular, a more timely, comprehensive, and accurate flow of information aboutfinancial sector operations would help improve the sector’s internal management, permit more effective supervision, and allow markets to make more informed judgments about underlying conditions, all of which would enhance the soundness of the financial and banking sectors.
I should note in passing that the advantages of transparency extend well beyond the financial sector. When policy actions and performance are transparent, policymakers have more incentive to pursue responsible policies, and the private sector can make more informed investment decisions. Moreover, markets can more readily distinguish between good performers and questionable ones, and the risk of contagion is diminished. But transparency also serves a wider purpose: it diminishes the opportunities for corruption and provides a stronger basis for public confidence in their leaders and support for their policies, which, after all, is a prerequisite for continued reform.
The third task is to improve the quality of public expenditure. This means reducing unproductive expenditure to make more room for investment in human capital and basic infrastructure. It also means ensuring that essential public services are provided at reasonable cost, that they reach the intended beneficiaries, and that access to these services is equitable. Finally, it means prioritizing spending programs, and increasing their cost effectiveness.
Given the need to increase the rate of sustainable growth and reduce income disparities, it is essential to improve the composition of expenditure on education, which at present is skewed toward higher education, and to ensure that children have access to basic health services. This would have a substantial positive impact on the quality of the workforce, and hence on Latin America’s long-term growth potential, and prospects for more equitable income distribution. But none of this can be achieved through higher deficits, which lead to inflation, or through higher taxes that dampen investment and growth. And none of this can be achieved unless all taxpayers pay their taxes!
Let me point out that Latin America has the distinction of currently spending less as a share of GDP on the military than any other region in the world. I sincerely hope that governments will resist the rising temptation to increase such expenditure—which would be lunacy after all the effort that has been expended to reduce tensions and promote regional cooperation—and recognize that these resources would be much better spent if used to improve the productive capacity of their economies and the skills of their workers. In this connection, let me pay tribute to the presidents of Latin America and their "Declaracion de Asuncion," in which they reiterated their decision to keep the region free of arms races.
A fourth task is labor market reform. This is an area in which there has been relatively less progress throughout the region, which, I believe, has had a dampening effect on social progress. Many people associate structural reform with higher unemployment and fear that labor market reform will only make the problem worse. I believe—and there is evidence to demonstrate—that they are mistaken. Certainly, as industry modernizes and the public sector reduces over-employment, there will be a short-term cost in terms of jobs lost. But postponing the adjustment required by these changes exacts a far higher human cost in terms of reduced growth and future lost jobs. The keys to preserving and expanding employment, particularly among the less skilled, are a flexible labor market that encourages mobility and keeps labor costs in line with labor productivity and sustained efforts to improve workers’ skills.
Perhaps you are surprised to hear the Managing Director of the institution at the heart of the international monetary system discussing issues such as accountability, transparency, justice, education, labor markets, and so forth. Certainly, my purpose is not to minimize the importance of monetary rigor or give short shrift to the strong fiscal policies needed to underpin monetary stability. Prudent monetary and fiscal policies are, in point of fact, essential and inescapable, the sine qua non for everything else. But they are not by themselves sufficient to accelerate economic and social progress in the decisive way required to impart to an economy the strength and resilience needed for it to participate actively and confidently in an open international economy. To increase the equality of economic opportunity, to attract more long-term investment, and compete successfully in global markets, broader policy action is required. Of course, developing economic and financial ties with the rest of the world is also essential—and makes for good business. But on this there is no need to insist, because so many in Latin America and elsewhere have already understood.
IMF EXTERNAL RELATIONS DEPARTMENT