Speech

Center for Global Development Book Forum
January 24, 2008

As prepared for delivery

When I received the invitation to come to the Center for Global Development to comment on the book by Nancy, Augusto and Rachel Menezes, I quickly accepted, since it would give me a chance to exchange views with old friends and colleagues. And it would also give me an opportunity to express my appreciation and to marvel at the impressive job that Nancy Birdsall has done to make the Center an important forum for discussing key policy issues facing all developing countries.

Turning to their book, I think this is a very important and useful contribution to the economic policy discussion of Latin America. Let me say at the outset that I agree fully with the book's central premise that, as the authors say, "that there are politically realistic win-win options for equity that will not sacrifice and can even enhance growth". I would add that policies that deal with equity, while encouraging growth, stand a much better chance of being sustainable, since they will enjoy broader domestic support. The book does a nice job of illustrating how many sound policies, ranging from fiscal discipline, lowering the cost of doing business, countercyclical provisioning requirements for banks, serve these dual, mutually reinforcing goals. And I like the approach to present the policy ideas as a toolkit—which correctly suggests that there is a menu of options that policymakers can draw from to tailor a policy that best fits their country's circumstances.

Perhaps I can begin with a few brief comments on current economic developments in the region. The region's economies have performed well over the past few years, and there has been a debate about whether this results from just good luck—low global interest rates, strong growth in trading partners and high world commodity prices—or hard work—that is a convincing commitment to strong economic policies and macroeconomic stability. What we are seeing is that, amidst all the turmoil in global financial markets, the economic performance of Latin America and the Caribbean has been one of the good stories in the global economy, which lends credence to the notion that strong policies have indeed played a very important role. Just to quickly review some of the key facts, in 2007, we estimate that the region grew by 5.4 percent, a bit faster than we had expected last October. Overall, the region ran an external current account surplus and built up a comfortable international reserve cushion. And most importantly we do not see any signs—at least yet—that the tight credit conditions in global financial markets are leading to a substantial tightening of credit conditions in the region. Of course, the outlook is full of uncertainty, with the prospect of slower global growth and perhaps declining commodity prices. I think the region's performance during the recent turmoil owes a lot to the strength of fiscal policies in many countries that helped reduce the region's public debt further in 2007. Also, in general, central banks stayed focused on limiting inflation, while relying on exchange rate flexibility to help absorb the effects of the turmoil in financial markets.

This recent macroeconomic picture actually ties in very nicely with the book's key theme. In chapter one on rules-based fiscal discipline, the book explains that low fiscal deficits help reduce real interest rates and contain inflation, which are not only good for growth but also for improving equity. As we all know, inflation is among the most regressive taxes, and high interest rates limit opportunities for small creditworthy firms and poor households. And in the next chapter on smoothing booms and busts, the book stresses that economic volatility is bad for both growth and income distribution. On growth, high volatility discourages investment, especially in projects with a long-time horizon and limits the development of local financial markets. With regard to income distribution, high volatility hits the poor especially hard, since they have fewer means to protect themselves and short-term costs can have long-term implications. So Latin America's performance over the past year suggests that the region's strong policies, which are anchored by good fiscal policies and a much clearer commitment to low inflation, are conducive to sustaining growth and are moving in the direction of doing a better job of promoting equity.

I would also like to spend a few moments concentrating on one of the underlying issues that the book raises and that the Fund has looked at as well and this is the role of globalization. In their book, Nancy, Augusto and Rachel argue that globalization has contributed to the growing sense of economic insecurity among middle and low-income households in Latin America. With closer ties to global markets, countries can become more vulnerable to sudden stops of capital flows and increased competition from products of other countries can harm employment. However, the authors do not oppose globalization per se but instead support an approach to globalization that includes policies that ameliorate the costs that can come from making economies more open. For example, in Chapter 12, they recognize that trade openness benefits the region but add that free trade agreements should include programs, such as worker retraining, to facilitate the adjustment to the new trade regime.

In our latest World Economic Outlook (WEO), we looked closely at the issue of globalization and inequality. The WEO found that overall, globalization has had a relatively small on inequality, while technological progress has made the biggest contribution to rising income inequality over the past two decades. For developing countries as a group, globalization has actually tended to reduce inequality, offsetting some of the adverse effects of technological progress. In particular, rising agricultural exports and tariff liberalization have, in fact, helped improve income distribution in developing countries. In advanced countries, additional imports from developing countries tend to reduce inequality in those countries. The WEO, however, did find that foreign direct investment, on average, tended to worsen the income distribution, as these inflows have raised the demand for skilled labor—similar to the effect of technological progress. Similar to the book's point about trade liberalization, this is not an argument against foreign direct investment or technological progress for that matter, which bring many benefits to countries. Instead countries that receive FDI need to make increased access to education a priority to allow those with less skills, and presumably lower incomes, to benefit from these inflows. Finally, the WEO also finds that financial deepening can enhance growth but also add to inequality. Once again the right policy response is to encourage financial deepening but also to include policies that broaden access to financial services to all segments of society.

In conclusion, let me compliment the authors for giving us a very thoughtful book that I am sure will influence the policy debate in Latin America for many years to come.