## _wp06252 - References

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### Introduction and recent regional performance
- Regional growth exceeded the historical average during 2004–06 and is continuing at a rapid clip, exceeding 4 percent.
- Inflation has trended down for more than a decade; poverty and unemployment indicators have shown remarkable improvement in some countries.
- The gap between per capita GDP in the United States and the region remained large.
- Paper objectives:
  - Draw lessons from Latin America’s long-term relative performance.
  - Assess priorities for sustaining the current expansion.

### Determinants of relative growth performance (Asia vs. Latin America)
- Core elements underpinning Asia’s success:
  - Conditions favoring high savings, capital accumulation, and productivity growth.
  - Stable macroeconomic environment and outward-oriented trade policies.
  - High rates of physical and human capital accumulation—investment rates rose to the 35 to 40 percent range—supported by strong domestic savings and rising financial intermediation.
  - Shift from capital-accumulation-driven growth to productivity-driven growth (total factor productivity) in many Asian countries.
  - Use of trade openness and foreign direct investment to facilitate technology adoption and competition; complementary role of the state in maintaining macro stability and investor-friendly environments.
- Contrast with Latin America:
  - Less successful in promoting sustained savings and investment trends needed to spur productivity growth.
  - Public sector dissaving has generally been the norm; private sector did not fully offset government deficits.
  - Productivity growth decelerated in the 1970s; capital accumulation collapsed during the 1980s (“lost decade”).
  - Protracted barriers to competition (largely associated with the import-substitution strategy) contributed to relative stagnation in productivity.

### Empirical comparison of growth sources (selected figures, 1960–2003)
- Table 1, aggregate row for 1960–2003 (Output per worker; Contribution of: Capital 2/; TFP per worker):
  - Latin America: Output per worker 1.0; Capital 2/ 0.9; TFP 0.1
  - East Asia (excluding China): Output per worker 3.8; Capital 2/ 2.8; TFP 1.0
  - China: Output per worker 5.0; Capital 2/ 2.2; TFP 2.7
  - India: Output per worker 2.5; Capital 2/ 1.4; TFP 1.1
- Notes:
  - Sources: Bosworth and Collins (2003); updated tables, The Brookings Institution.
  - 1/ Excluding China.
  - 2/ Includes physical capital and education.

### Lessons and policy implications drawn in the text
- Key lessons from Asia relevant to Latin America:
  - Raise savings and investment to higher rates and sustain them.
  - Over time, increase the contribution of technological progress to achieve higher productivity growth.
  - Harness opportunities from international trade and globalization to facilitate technology adoption, competition, and private-sector dynamism.
  - Maintain macroeconomic stability (low inflation, exchange rate stability) and a broadly investor-friendly competitive environment.
- Latin America’s policy challenges:
  - Entrench macroeconomic stability and sustain reforms to promote financial intermediation and broader economic reforms.
  - Address legacy of import-substitution barriers to competition.
  - Learn from country exceptions (e.g., Chile) where capital and productivity growth continued through crisis and accelerated since the 1990s.

### Box 1. Chile: Institutions and Policies Underpinning Stability and Growth
- Macroeconomic performance:
  - Over the last twenty years, Chile enjoyed strong growth and macroeconomic stability with faster and smoother trend economic growth, and lower and less volatile inflation than in other Latin American economies.
  - Policy framework enabled Chile to withstand “sudden stops” to capital flows and reap benefits of open external trade and capital markets without giving back gains during global financial crises.
- Central bank policy:
  - Credible inflation targeting framework aiming at keeping inflation within a 2–4 percent target range; in recent years the central bank has also let the peso float freely.
- Main policies underpinning Chile’s success:
  - Strong fiscal discipline
    - Only in Chile were years of fiscal deficits roughly offset by years of surpluses; structural surplus rule introduced in 2000.
    - Fiscal discipline resulted in a vastly lower debt-servicing burden, lower government debt, and lower real interest rates.
  - Credible inflation targeting framework: central bank aims at keeping inflation within a 2–4 percent target range.
  - Strengthened financial system and deeper capital markets: balance of market discipline and sound banking supervision while capital markets rapidly deepened.
  - Trade integration and financial opening: export sector among the most open and diversified in Latin America, acting as buffer against current account shocks and boosting growth potential.
  - Institutional arrangements: stable institutional framework and reforms reduced incentives problems that led to lack of fiscal discipline, distorted trade policies, and moral hazard in the financial system.

### Regional contrasts: growth spells, poverty, and inequality
- Growth spells:
  - Berg and others (2006): less than half of growth spells initiated in Latin America in the post-War period continued after seven years, versus over 85 percent for high-income countries, and 100 percent for emerging Asia.
- Poverty examples:
  - India: ratio below national poverty line fell from almost 40 percent in 1987–88 to almost 25 percent in 1999–2000 in rural areas; urban areas from 23 percent to 12.5 percent.
  - China: rural poverty fell from 31 percent in 1979 to 9½ percent in 1990 and to 4½ percent in 1998.
- Regional convergence has been slow in Latin America; dispersion in per capita output across regions declined relatively slowly in several countries.

### Key explanatory macroeconomic factors for growth differences
- Stable macroeconomic policies reduce uncertainty and foster capital accumulation and productivity (Fischer, 1993).
- Empirical factors positively associated with growth:
  - Price stability (low and steady inflation).
  - Trade openness.
  - Financial system stability and development.
  - Good fiscal performance and undistorted foreign exchange markets.
- Policy volatility, fiscal procyclicality, exchange rate crises, and reform reversals correlate with dissipating growth spells (Berg and others, 2006; Sahay and Goyal, 2006).

### Volatile fiscal policy, budgetary rigidities, and debt
- Fiscal volatility harms growth primarily by reducing productivity; discretionary fiscal volatility is particularly damaging.
- Budget rigidities (revenue earmarking, minimum expenditure requirements, mandatory transfers) are widespread; Alier’s estimates show more than three-quarters of federal government budgets in Argentina, Brazil, and Ecuador are inflexible.
- Procyclicality (KRV measure), selected figures:
  - Latin America 0.12 (1963–90) 0.35 (1990–2005)
  - Argentina 0.22 (1963–90) 0.55 (1990–2005)
  - Chile 0.17 (1963–90) 0.08 (1990–2005)
  - Colombia -0.32 (1963–90) 0.31 (1990–2005)
  - Mexico 0.04 (1963–90) 0.11 (1990–2005)
  - Uruguay 0.19 (1963–90) 0.56 (1990–2005)
  - Venezuela 0.40 (1963–90) 0.52 (1990–2005)
  - Asia 0.30 (1963–90) 0.03 (1990–2005)
  - China 0.26 (1963–90) 0.05 (1990–2005)
  - Hong Kong 0.15 (1963–90) -0.34 (1990–2005)
  - Korea 0.04 (1963–90) -0.40 (1990–2005)
  - India 0.33 (1963–90) 0.03 (1990–2005)
  - Indonesia 0.48 (1963–90) 0.00 (1990–2005)
  - Malaysia 0.60 (1963–90) -0.18 (1990–2005)
  - Philippines 0.58 (1963–90) 0.41 (1990–2005)
  - Thailand -0.04 (1963–90) 0.65 (1990–2005)
- Debt indicators, selected entries (In percent of GDP, Gral. Govt. Gross Debt; Total External Debt):
  - Latin America 38.5 (1993–2000) 43.5 (2005) 46.7 44.4 45.7 40.4
  - Argentina 30.6 (1993–2000) 51.1 (2005) 85.9 34.0 54.5 74.4
  - Brazil n.a. 67.6 75.1 33.2 36.1 21.3
  - Chile 29.7 14.0 14.2 5.9 40.2 49.4 39.4
  - Colombia n.a. 46.2 47.4 28.0 43.1 32.1
  - Mexico 27.3 49.3 45.1 32.2 28.7 22.5
  - Uruguay 32.3 38.5 69.9 36.0 44.3 68.4
  - Asia 1/ 57.5 58.4 51.7 43.0 61.4 41.0
  - China 9.4 20.0 19.3 13.9 12.2 13.4
  - India 76.8 75.7 84.8 34.0 22.1 17.3
  - Philippines 96.6 88.1 86.5 65.7 75.6 63.8
  - Source: IMF.
  - 1/ Excludes China and India.
- High debt can reduce growth potential; thresholds can be as low as 65 percent of exports or 20 percent of GDP; doubling debt at or above the threshold dampens annual per capita growth by about 1 percentage point.

### Debt structure and exposure to shocks
- Share of floating-rate and exchange rate-linked domestic debt rose markedly during the 1990s in Latin America, increasing susceptibility to shifts in domestic confidence and global capital market conditions.
- Asian economies generally kept gross public indebtedness lower and increased share of fixed rate debt.

### Monetary policy, exchange rate regimes, and crises
- Fiscal dominance historically undermined central bank independence, contributing to rapid monetary growth, high/hyperinflation, and disruptions associated with fixed-type exchange rate regimes.
- Edwards and Yeyati (2003): more rigid exchange rate regimes associated with amplified effects from terms of trade shocks; more flexible regimes tend to deal better with shocks.
- Reinhart and Rogoff (2004) indices: frequency and intensity of exchange rate changes in Latin America were much more than in other regions over the past 30 years.
- Latin American regimes included tablitas, dual/multiple rates, currency boards, full dollarization, and crawling pegs; these arrangements were typically undermined by unsustainable fiscal policies and ended in crises.
- Asia experienced fewer regime changes and less regime volatility, reflecting fiscal policies compatible with regimes and sometimes capital controls.

### Financial intermediation and banking crises
- Bank credit to the private sector in Latin America is on average about 30 percent of GDP—about a third of the level in advanced economies.
- Private sector credit (In percent of GDP), selected series:
  - Latin America 15.2 (1961–70) 22.2 (1971–80) 27.0 (1981–90) 29.6 (1991–2000)
  - East Asia (excl. Japan) 18.4 27.7 50.7 98.7
  - North America (US and Canada) 44.9 64.7 76.3 95.8
  - Western Europe 49.3 55.0 74.4 90.7
- Stock market capitalization in Latin America just over 40 percent of GDP, compared with nearly 100 percent in the G-7 and nearly 150 percent in East Asia.
- Macroeconomic volatility, past banking crises, interest rate controls, high reserve requirements, and financial transactions taxes weakened incentives to build deposit bases and raised intermediation margins.
- Banking and currency crises have been more frequent in Latin America; currency crises coupled with banking crises yield larger cumulative output losses.

### Reform reversals and policy credibility
- Asia: earlier and steadier implementation of market-oriented reforms with fewer reversals; China’s reforms described as “incremental and experimental.”
- Latin America: reforms were uneven, often interrupted by crises and reversals—Chile a notable exception with reform indices reaching industrial-country levels.
- Sustained reforms correlate with faster and less volatile growth; reversals are strongly related to macroeconomic volatility.

### Recent progress toward stability and sustained growth
- Since early 1990s many Latin American countries strengthened macroeconomic policies:
  - Central banks gained operational independence and accountability; inflation fell to single-digit rates in a clear majority of countries.
  - Fiscal discipline improved: budget deficits and indebtedness have been trending downwards; active debt management extended maturities and raised share of fixed rate domestic debt.
  - Financial intermediation has risen with regulatory and supervisory improvements, improved credit risk information, contract enforcement, and loan recovery procedures.
- Remaining frictions:
  - Intermediation costs and real interest rates remain well above other regions; public banks still play significant roles.
  - Net interest margins (1995–2004 averages) and effective reserve requirements (as of December 2005) remain elevated in Latin America compared with Asia.
- Trade and financial integration:
  - Ratio of total external trade to GDP rose by more than 10 percentage points on average during the 1990s for Latin America.
  - Gross capital inflows to GDP rose notably in Argentina, Chile, and Venezuela.
- Composition of private capital inflows:
  - 1992–97 composition: 42% FDI, 11% portfolio equity, 47% debt.
  - 2002–05 composition: 33% FDI, 57% portfolio equity, 9% debt.
- Equity inflows and FDI have surged; nonresident holdings of government bonds increased notably in Brazil, Colombia, and Mexico.

### Suggested policy priorities for consolidating stability and boosting growth
- Lessen the government burden on the economy:
  - Balance new government spending commitments with further progress toward debt reduction to avoid imparting a procyclical impetus.
  - Few countries have followed Chile’s example of ensuring lasting savings out of windfall commodity earnings.
- Advance fiscal reforms to help both growth and equity:
  - Reform tax structures (especially tax exemptions that favor upper-income groups) and high subsidies (often energy subsidies that do not benefit the poor).
  - Gradually phase out minimum expenditure requirements and budgetary rigidities to allow reallocation toward public investment, education, and social assistance.
  - Use strengthened fiscal institutions to reduce rigidities while limiting discretionary fiscal policy volatility.
- Improve public infrastructure:
  - Greater budgetary flexibility to raise public investment where deficient; prioritize port efficiency and reductions in transportation costs.
- Solidify monetary and exchange rate frameworks:
  - Strengthen credibility of inflation targeting regimes by consistently meeting official targets.
  - Preserve commitment to flexible exchange rate regimes and enhance transparency of intervention policies; institutionalize central bank autonomy.
- Provide banking systems with better means of supporting growth:
  - Reduce tax burden on financial intermediation and high reserve requirements (notably Brazil and Paraguay).
  - Limit the role of public banks, lower barriers to entry via privatization, restructuring, and increased foreign participation to foster competition and reduce margins.
  - Build policy credibility to reduce dollarization and enhance banking support for growth.
- Continue to enhance the business environment and proceed with further trade liberalization:
  - Fortify the judiciary, strengthen enforcement of contractual obligations, and increase transparency and stability of rules governing private investment.
  - Take advantage of unilateral and multilateral initiatives to further liberalize external trade.
  - Proceed with labor market reforms to increase flexibility and remove restrictions that impinge on labor demand, wages, and productivity.

*Source document: _wp06252 - References..............................................................................................................*

### References..............................................................................................................

### _wp06252 - References..............................................................................................................

### Introduction and recent regional performance
- Latin America entered a resurgent phase: regional growth exceeded the historical average during 2004–06 and is continuing at a rapid clip, exceeding 4 percent.
- Macroeconomic stability has been generally well maintained: inflation has trended down for more than a decade, and poverty and unemployment indicators have shown remarkable improvement in some countries.
- The region’s recent performance contrasts with the post-World War II period when Latin America underperformed relative to most other regions; the gap between per capita GDP in the United States and the region remained large.
- The paper’s objectives:
  - Draw lessons from Latin America’s long-term relative performance.
  - Assess priorities for sustaining the current expansion.

### Determinants of relative growth performance (Asia vs. Latin America)
- Core elements underpinning Asia’s success:
  - Creation of conditions favoring high savings, capital accumulation, and productivity growth.
  - Stable macroeconomic environment and outward-oriented trade policies.
  - High rates of physical and human capital accumulation—investment rates rose to the 35 to 40 percent range—supported by strong domestic savings and rising financial intermediation.
  - Over time, a shift from capital-accumulation-driven growth to productivity-driven growth (total factor productivity) in many Asian countries.
  - Use of trade openness and foreign direct investment to facilitate technology adoption and competition; complementary role of the state in maintaining macro stability and investor-friendly environments.
- Contrast with Latin America:
  - Less successful in promoting sustained savings and investment trends needed to spur productivity growth.
  - Public sector dissaving has generally been the norm; private sector did not fully offset government deficits.
  - Productivity growth decelerated in the 1970s; capital accumulation collapsed during the 1980s (“lost decade” for many large economies).
  - Protracted barriers to competition (largely associated with the import-substitution strategy) are identified contributors to relative stagnation in productivity.

### Empirical comparison of growth sources (Table summary)
- Table 1 ("A Comparison of Sources of Growth, 1960–2003") — selected aggregate row for 1960–2003 (Output per worker; Contribution of: Capital 2/; TFP per worker):
  - Latin America: Output per worker 1.0; Capital 2/ 0.9; TFP 0.1
  - East Asia (excluding China): Output per worker 3.8; Capital 2/ 2.8; TFP 1.0
  - China: Output per worker 5.0; Capital 2/ 2.2; TFP 2.7
  - India: Output per worker 2.5; Capital 2/ 1.4; TFP 1.1
- Notes from table:
  - Sources: Bosworth and Collins (2003); updated tables, The Brookings Institution.
  - 1/ Excluding China.
  - 2/ Includes physical capital and education.

### Lessons and policy implications drawn in the text
- Key lessons from Asia relevant to Latin America:
  - Raise savings and investment to higher rates and sustain them.
  - Over time, increase the contribution of technological progress to achieve higher productivity growth.
  - Harness opportunities from international trade and globalization to facilitate technology adoption, competition, and private-sector dynamism.
  - Maintain macroeconomic stability (low inflation, exchange rate stability) and a broadly investor-friendly competitive environment.
- Latin America’s policy challenges noted:
  - Need to entrench macroeconomic stability and sustain reforms to promote financial intermediation and broader economic reforms.
  - Address legacy of import-substitution barriers to competition that have impeded productivity growth.
  - Learn from country exceptions (e.g., Chile) where capital and productivity growth continued through crisis and accelerated since the 1990s.

*Italic: Source document: _wp06252 - References..............................................................................................................*

### Box 1. Chile: Institutions and Policies Underpinning Stability and Growth 1/

### Box 1. Chile: Institutions and Policies Underpinning Stability and Growth 1/

### Chile’s macroeconomic performance and institutional underpinnings
- Over the last twenty years, Chile has enjoyed strong growth and macroeconomic stability characterized by faster and smoother trend economic growth, and lower and less volatile inflation than in other Latin American economies.
- The policy framework and long-term institutional underpinnings enabled Chile to withstand “sudden stops” to capital flows and to reap the benefits of open external trade and capital markets without giving back these gains during global financial crises.
- Central bank policy: a credible inflation targeting framework aiming at keeping inflation within a 2–4 percent target range; in recent years the central bank has also let the peso float freely.

### Main policies underpinning Chile’s success
- Strong fiscal discipline
  - Over the last two decades, only in Chile were years of fiscal deficits roughly offset by years of surpluses; fiscal discipline was reinforced by the introduction of the structural surplus rule in 2000.
  - Fiscal discipline resulted in a vastly lower debt-servicing burden, lower government debt, and lower real interest rates.
- Credible inflation targeting framework
  - Central bank aims at keeping inflation within a 2–4 percent target range.
- Strengthened financial system and deeper capital markets
  - Chile struck a balance of market discipline and sound banking supervision while capital markets rapidly deepened.
- Trade integration and financial opening
  - Chile’s export sector is among the most open and diversified in Latin America and has acted as a buffer against current account shocks while boosting growth potential.
- Institutional arrangements
  - Stable institutional framework and reforms reduced incentives problems that often led to lack of fiscal discipline, distorted trade policies, and moral hazard in the financial system.

*Based on Kalter and others (2004).*

### Regional contrasts: growth spells, poverty, and inequality
- Berg and others (2006): less than half of growth spells initiated in Latin America in the post-War period continued after seven years, as opposed to over 85 percent for high-income countries, and 100 percent for emerging Asia.
- Poverty and inequality
  - India: ratio of population below national poverty line fell from almost 40 percent in 1987–88 to almost 25 percent in 1999–2000 in rural areas; urban areas from 23 percent to 12.5 percent.
  - China: rural poverty fell from 31 percent in 1979 to 9½ percent in 1990 and to 4½ percent in 1998.
- Regional convergence has been slow in Latin America; dispersion in per capita output across regions declined relatively slowly in several Latin American countries.

### Key explanatory macroeconomic factors for growth differences
- Stable macroeconomic policies reduce uncertainty and foster capital accumulation and productivity (Fischer, 1993).
- Empirical factors positively associated with growth include:
  - Price stability (low and steady inflation).
  - Trade openness.
  - Financial system stability and development.
  - Good fiscal performance and undistorted foreign exchange markets.
- Episodes of policy volatility, fiscal procyclicality, exchange rate crises, and reform reversals correlate with dissipating growth spells (Berg and others, 2006; Sahay and Goyal, 2006).

### Volatile fiscal policy and budgetary rigidities
- Fiscal volatility harms growth primarily by reducing productivity; discretionary fiscal volatility is particularly damaging.
- Figure evidence (1960–2000): volatility of discretionary fiscal policy generally negatively related to growth across a sample of 92 countries.
- Budget rigidities (revenue earmarking, minimum expenditure requirements, mandatory transfers) are widespread in some Latin American federal budgets; Alier’s estimates show more than three-quarters of federal government budgets in Argentina, Brazil, and Ecuador are inflexible (Figure 5).
- Procyclicality (KRV measure)
  - Table 2. Procyclicality of Fiscal Policy (KRV Measure)
    - 1963–90 1990–2005
    - Latin America 0.12 0.35
    - Argentina 0.22 0.55
    - Brazil ... 0.33
    - Chile 0.17 0.08
    - Colombia -0.32 0.31
    - Mexico 0.04 0.11
    - Uruguay 0.19 0.56
    - Venezuela 0.40 0.52
    - Asia 0.30 0.03
    - China 0.26 0.05
    - Hong Kong 0.15 -0.34
    - Korea 0.04 -0.40
    - India 0.33 0.03
    - Indonesia 0.48 0.00
    - Malaysia 0.60 -0.18
    - Philippines 0.58 0.41
    - Thailand -0.04 0.65
- High public debt has been widespread, with Chile a notable exception (Table 3).
  - Table 3. Debt Indicators, 1993–2005 (In percent of GDP)
    - Gral. Govt. Gross Debt  Total External Debt
    - 19932000 2005 19932000 2005
    - Latin America 38.543.5 46.7 44.445.7 40.4
    - Argentina 30.651.1 85.9 34.054.5 74.4
    - Brazil n.a.67.6 75.1 33.236.1 21.3
    - Chile 29.714.0 14.2 5.9 40.249.4 39.4
    - Colombia n.a.46.2 47.4 28.043.1 32.1
    - Mexico 27.349.3 45.1 32.228.7 22.5
    - Uruguay 32.338.5 69.9 36.044.3 68.4
    - Asia 1/ 57.558.4 51.7 43.061.4 41.0
    - China 9.420.0 19.3 13.912.2 13.4
    - India 76.875.7 84.8 34.022.1 17.3
    - Philippines 96.688.1 86.5 65.775.6 63.8
    - Source: IMF.
    - 1/ Excludes China and India.
- High debt can reduce growth potential; thresholds can be as low as 65 percent of exports or 20 percent of GDP; doubling debt at or above the threshold dampens annual per capita growth by about 1 percentage point.

### Debt structure and exposure to shocks
- Share of floating-rate and exchange rate-linked domestic debt rose markedly during the 1990s in Latin America, increasing susceptibility to shifts in domestic confidence and global capital market conditions (Figure 6).
- Asian economies generally kept gross public indebtedness lower and increased share of fixed rate debt.

### Monetary policy, exchange rate regimes, and crises
- Fiscal dominance historically undermined central bank independence, contributing to rapid monetary growth, high/hyperinflation, and disruptions associated with fixed-type exchange rate regimes.
- Edwards and Yeyati (2003): more rigid exchange rate regimes associated with amplified effects from terms of trade shocks; more flexible regimes tend to deal better with shocks.
- Reinhart and Rogoff (2004) indices: frequency and intensity of exchange rate changes in Latin America were much more than in other regions over the past 30 years (Figure 7).
- Latin American regimes included tablitas, dual/multiple rates, currency boards, full dollarization, and crawling pegs; these fixed-type arrangements were typically undermined by unsustainable fiscal policies and ended in crises.
- Asia experienced fewer regime changes and less volatility in regimes, reflecting fiscal policies compatible with regimes and sometimes capital controls.

### Financial intermediation and banking crises
- Latin America lags in financial intermediation: bank credit to the private sector is on average about 30 percent of GDP—about a third of the level in advanced economies.
- Table 4. Private Sector Credit (In percent of GDP)
  - 1961–70 1971–80 1981–90 1991–2000
  - Latin America 15.2 22.2 27.0 29.6
  - East Asia (excl. Japan) 18.4 27.7 50.7 98.7
  - Middle-East and Central Asia 24.5 37.9 43.3 47.2
  - North America (US and Canada) 44.9 64.7 76.3 95.8
  - South-Asia 10.1 15.4 20.4 21.2
  - Sub Saharan Africa 19.6 22.3 22.7 25.0
  - Western Europe 49.3 55.0 74.4 90.7
  - Sources: International Financial Statistics, and WDI.
- Stock market capitalization in Latin America stands at just over 40 percent of GDP, compared with nearly 100 percent in the G-7 and nearly 150 percent in East Asia.
- Macroeconomic volatility, past banking crises, interest rate controls, high reserve requirements, and financial transactions taxes weakened incentives to build deposit bases and raised intermediation margins.
- Banking and currency crises have been more frequent in Latin America (Figure 8); currency crises coupled with banking crises yield larger cumulative output losses.

### Reform reversals and policy credibility
- Asia: earlier and steadier implementation of market-oriented reforms with fewer reversals; China’s reforms characterized as “incremental and experimental.”
- Latin America: reforms were uneven, often interrupted by crises and reversals—Chile is a notable exception with reform indices reaching industrial-country levels.
- Reforms that were sustained correlate with faster and less volatile growth; reversals are strongly related to macroeconomic volatility.

### Recent progress toward stability and sustained growth
- Since early 1990s many Latin American countries strengthened macroeconomic policies:
  - Central banks gained operational independence and accountability; inflation fell to single-digit rates in a clear majority of countries.
  - Fiscal discipline improved: budget deficits and indebtedness have been trending downwards; active debt management extended maturities and raised share of fixed rate domestic debt.
  - Financial intermediation has risen with regulatory and supervisory improvements, improved credit risk information, contract enforcement, and loan recovery procedures.
- Remaining frictions: intermediation costs and real interest rates remain well above other regions; public banks still play significant roles.
  - Net interest margins (1995–2004 averages) and effective reserve requirements (as of December 2005) remain elevated in Latin America compared with Asia.
- Trade and financial integration rose: for Latin America, ratio of total external trade to GDP rose by more than 10 percentage points on average during the 1990s; gross capital inflows to GDP rose notably in Argentina, Chile, and Venezuela.
- Composition of recent private capital inflows (1992–97 vs 2002–05):
  - 1992–97 composition: 42% FDI, 11% portfolio equity, 47% debt.
  - 2002–05 composition: 33% FDI, 57% portfolio equity, 9% debt.
- Equity inflows and FDI have surged; nonresident holdings of government bonds increased notably in Brazil, Colombia, and Mexico.

### Suggested policy priorities for consolidating stability and boosting growth
- Lessen the government burden on the economy
  - Carefully balance new government spending commitments with further progress toward debt reduction to avoid imparting a procyclical impetus.
  - Few countries have followed Chile’s example of ensuring lasting savings out of windfall commodity earnings.
- Advance fiscal reforms to help both growth and equity
  - Reform tax structures (especially tax exemptions that favor upper-income groups) and high subsidies (often energy subsidies that do not benefit the poor).
  - Gradually phase out minimum expenditure requirements and budgetary rigidities to allow reallocation toward public investment, education, and social assistance.
  - Use strengthened fiscal institutions to reduce rigidities while limiting discretionary fiscal policy volatility.
- Improve public infrastructure
  - Greater budgetary flexibility to raise public investment where deficient; prioritize port efficiency and reductions in transportation costs.
- Solidify monetary and exchange rate frameworks
  - Strengthen credibility of inflation targeting regimes by consistently meeting official targets.
  - Preserve commitment to flexible exchange rate regimes and enhance transparency of intervention policies; institutionalize central bank autonomy.
- Provide banking systems with better means of supporting growth
  - Reduce tax burden on financial intermediation and high reserve requirements (notably Brazil and Paraguay).
  - Limit the role of public banks, lower barriers to entry via privatization, restructuring, and increased foreign participation to foster competition and reduce margins.
  - Build policy credibility to reduce dollarization and enhance banking support for growth.
- Continue to enhance the business environment and proceed with further trade liberalization
  - Fortify the judiciary, strengthen enforcement of contractual obligations, and increase transparency and stability of rules governing private investment.
  - Take advantage of unilateral and multilateral initiatives to further liberalize external trade.
  - Proceed with labor market reforms to increase flexibility and remove restrictions that impinge on labor demand, wages, and productivity.

*Italic line: Source: IMF working paper Box 1 text.*

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