The Way Forward for Reform in Latin AmericaSpeech by Rodrigo de Rato
Managing Director of the International Monetary Fund
at the Latin American Business Association Conference
Columbia Business School
February 16, 2007
1. Thank you for inviting me to this conference. It is a pleasure to be here at Columbia, and with this group.
2. The agenda for this session asks both how the economies of the Latin American countries are performing, and also what are the implications of recent election results for the future. The juxtaposition of these questions suggests a certain tension. Perhaps this is because while economic performance in the region is generally good, political developments suggest that voters remain uncertain, and in some cases dissatisfied, about both economic outcomes and the policies that have produced them. Without delving too deeply into the politics of individual countries, I would like to explore the reasons for the apparent inconsistency of economic and political developments. I will suggest that the dissatisfaction of voters has its roots in real economic problems, especially in growth which remains too low and in poverty levels which remain too high in many countries. I will also make some suggestions for a way forward for economic reform in Latin America which will address these problems.
3. I will begin though with recent economic developments, and with a simple statement: the region is doing well. Indeed, 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 2006, real economic growth was around 5 percent. For the current year, we expect growth to ease slightly but to remain above 4 percent. This would make the current expansion the best for sustained strong growth in the region 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 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 a great deal to good 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 good performance, some political candidates have questioned both the quality of the outcomes of recent years and the policies that produced those outcomes, and their questions have resonated with voters. What should we make of these developments?
5. My first response is that we should not overstate the populist phenomenon. While leaders with populist agendas were elected in some countries last year, in several other countries governments with a strong public commitment to reform were elected or re-elected. Also, the distinction between populists and reformists obscures many nuances in the policies favored by different governments. Moreover, we should remember that one of the most striking and positive developments in Latin America in recent decades has been the blossoming of democracy. This is good in itself and good for economic policy. Whatever the details of their programs, elected governments have the legitimacy and the political strength to implement reforms. It is no coincidence that the broadening of democracy has been accompanied by stronger macroeconomic management in many countries.
6. Nevertheless, the concerns that voters in many countries have expressed over the past year reveal genuine sources of economic discontent. Despite the progress of recent years, rates of growth are still low relative to other regions or compared to the levels needed to enable low-income countries to achieve the Millennium Development Goals. Meanwhile, the benefits of growth have been unevenly distributed, and levels of poverty and inequality are still too high in many countries. The question then is what are the best policies to address these problems?
7. The approach which most governments have taken, and which the Fund has supported, is that in general, going further in the direction of reform would lead to more progress in raising growth and lowering poverty. Where progress has not been made, the problem is often that reforms have not gone far enough, and that many reforms are incomplete.
8. This view is supported by the Fund's experience in other regions around the world. It is also supported by the evidence in Latin America. Cross-country studies based on both economic indicators and direct measurements of reform show that growth has been better in countries where macroeconomic policy has been strongest and where structural reforms have gone furthest. In macroeconomic policy, avoiding crises and inflationary episodes is extremely important in generating sustained growth. In the area of structural reform, countries that liberalized trade and reformed the role of the state in the private sector have performed particularly well. The effectiveness of a combination of macroeconomic stability and structural reform can be seen, for example, in the relative success of Chile, which in the last 25 years has managed the highest per capita income growth in the region. More generally, regions and countries that have become most integrated into the global economy and have pursued trade in goods and services most vigorously are those which have prospered in an increasingly globalized world. Further support for trade liberalization and also for privatization comes from studies based on specific industries in various countries. These studies show that both trade liberalization and privatization raised labor productivity in these industries, contributing to growth.
9. Nevertheless, and despite more countries embracing reform, the goals of sustained high growth and poverty reduction remain elusive in many countries. This has led some commentators to ask whether we are missing something. For example, some commentators would argue that poverty remains high because reforms have gone too far in reducing the role of the state as a provider of public goods. Others would argue that growth remains low because reforms have been targeting the wrong problems and that, for example, a greater focus on institutions is needed. Others argue that every country needs a different reform agenda based on its own position, culture, and needs, and that an attempt to import a reform model from outside does not serve countries well. These arguments need to be answered. Let me take each in turn.
10. I will begin with the question of whether a larger role for the state could help, which is the view underlying policies in some countries. My answer is that there are some areas where governments need to do more, but there are also areas where they need to do less. Of course there are many activities that the state needs to perform, and perform well. These include maintaining law and order-a pervasive problem, for example, in many Central American countries. They include maintaining a sound monetary system and financial sector supervision and regulation. And they include building and maintaining an adequate infrastructure. But in some of these activities there are also tradeoffs. For example, public investment in infrastructure has clear benefits. But these must be compared with the benefits from spending on other priorities, for example health and education. And it must be set against the costs of higher taxes and against the risks of macroeconomic instability if higher expenditures are covered by deficit financing. There are also activities in which the state has not performed well in the past. For example, policies which aim at the promotion of specific industries have often ended up supporting industries which benefit narrow interest groups. Moreover, where governments create easier conditions for state-owned or other favored businesses, it imposes additional costs on their competitors. The fostering of such a dual economy impedes investment and growth in the economy as a whole.
11. With regards to the argument that there needs to be a greater focus on institutions, I think there is much merit in this. Indeed, it is increasingly accepted that the institutional structure-the arrangements, both formal and informal, which set the framework for economic policy, commerce, and political life-have great influence on a country's growth prospects. This may mean that countries can only improve their growth prospects if they are prepared to change and reform deep institutional structures. It may mean that to create durable reforms you also need to create durable constituencies for reform.
12. The question then is what can outside agencies, such as the International Monetary Fund, do to help countries improve their institutional frameworks? My answer is that we must be conscious of our limitations in promoting institutional reform. Key institutional decisions, such as the political structure, the level of authority of the executive, and the power of the courts, are best made-indeed, perhaps can only be made-from within countries. And institutions like the Fund must take our member countries and, for the most part, their institutions, as we find them.
13. What the Fund and other outsiders can do is to use examples and arguments to persuade countries of the merits of particular institutional arrangements. A classic example in the area of economic institutions is the growing international recognition over the last twenty years of the virtues of independent central banks. The Fund has been part of this movement, showing how central bank independence can help contain inflation. International institutions and aid donors can also help by providing technical assistance to countries which are pursuing institutional change. For example, the Fund has not just advocated central bank independence. We have also given countries concrete technical assistance in designing statutes and central bank charters which promote it. Similarly, the Fund has not just advised countries to improve tax administration but has given concrete assistance to help countries improve customs and internal revenue services. The same is true on issues such as public expenditure control, debt monitoring, and managing the macroeconomic implications of aid inflows. These are all areas where the Fund has some comparative advantage and where we have shared our expertise with member countries. But we have always trod lightly in this area, and we must continue to do so.
14. Finally, there is the argument that all countries have different problems and constraints to growth. This is a serious issue, and there is some serious work underway in the economics profession on how to address it-for example, with the use of growth diagnostics and decision trees on what are the critical areas of reform in specific countries. It is also an issue with which the Fund is comfortable. We devote a great deal of resources to sending teams of staff to countries for the express purpose of getting to know their unique economies, and understanding how their problems differ from others. But it also remains true that all countries must compete in the global economy, and many face common problems, such as dealing with demographic changes and maintaining financial stability. The laws of economics do not change when you cross national borders. So it still makes sense to attempt to identify constraints that have impeded growth in many countries and policies that can overcome those constraints.
15. To sum up, I believe that the citizens of Latin America are right to be concerned about rates of growth that are still too low and rates of poverty that are still too high. They are right to ask searching questions about whether the policy mix is correct. Both their governments and international institutions like the Fund must continue looking for better answers. And some of these answers may require closer attention to institutional frameworks and more systematic efforts to determine what are the specific constraints in individual countries.
16. But we must also not lose sight of what has worked and what continues to work. For example, we know that fiscal prudence is necessary for macroeconomic stability. We know that keeping inflation down helps the poor, who are least able to protect themselves from volatile prices. We know that structural reforms like trade liberalization, privatization, and financial sector reform can raise growth and reduce poverty. Indeed, a large part of the progress that Latin American countries have made in recent years is a result of their having put these principles into practice. The way forward then is to continue with policies that have been shown to work, to refine these policies where necessary to promote further growth and address poverty and inequality, and to do so with sensitivity to both the importance of institutions and the circumstances of individual countries.
17. Thank you very much.