Crisis: Latin America's Opportunity

Latin Business Chronicle

BY MARCELO M. GIUGALE, World Bank Regional Director for Poverty Reduction and Economic Management.

Wednesday, June 17, 2009
Latin America had rarely had it so nice. Over the past five years, good policies and good luck had put it on a path to prosperity. Slowly the mass of its poor was shrinking. Without saying it too loud, Latin Americans adapted the “Washington Consensus” to forge their own—they began to demand economic stability, social solidarity, technological modernity and public decency. And, a few countries aside, they were getting just that. Out went inflation, default, isolation, exclusion, uncertainty. In came budget surpluses, investment grades, free-trade agreements, cash transfers, institutions. There was still a long way to go, but progress was real.

But just when things seemed on track, the world implodes. The first global crisis in almost a century reaches the region—and will hit it hard. From fast growth, its economy will suddenly go in reverse. How should Latin governments respond? Should they follow the rich world down a path that looks uncomfortably similar to, well, the old Latin America? Can they tailor their reaction and position their nations for the recovery? Is there an opportunity behind and beyond the crisis?



MORE GROWTH THAN DEVELOPMENT



Not since the 60s did Latin American economies grow so fast. On average, they expanded at over five percent per year since 2003 — not China, but pretty good. Yes, much of the growth (perhaps as much as half of it) was due to record high prices for the commodities the region sells, things like oil, copper or soybean. But the bonanza was not entirely wasted. Some fundamental changes were afoot, changes not just in public policy but in societal values.



For the first time, most countries in the region posted fiscal surpluses, year after year. In fact, sound budget management became a political asset, and voters began to reward those that could show the flag of good administration. In a sign of the times, several congresses passed fiscal responsibility laws, emphasis on “responsibility.” Central banks, formerly pawns with the money-printing machines, grew more independent, more transparent, more competent, and were given an explicit mandate to keep inflation low. Half a dozen of them even committed publicly to “inflation targets”, and delivered. And they all got more serious about supervising private bankers — no subprime free-for-all here. Public debt was cut and its terms improved. Virtually every country reduced government liabilities in proportion to the size of its economy, a gift to the next generation of Latin American taxpayers. Credit rating agencies even bestowed investment-grade status on the sovereign bonds of seven Latin-American countries. But, unlike the 1970s, the access to credit was not used to over-borrow.



All that macroeconomic virtue was making a difference in people’s lives. Poverty began to fall under the weight of sustained growth and smarter social policies. Actually, the region pioneered the world’s most effective form of social assistance—conditional cash transfers, a payment to poor parents that stick with poverty-busting behaviors, like keeping their kids in school or vaccinated. Inequality remained sky-high, but it did not get worse, as it used to do every time the region prospered. (See chart 1 in the PDF document uner the photo).



It is true, not every country followed the same path. A handful made a U-turn and scared away investors. But, on the whole, successful leaders were those that managed to balance economic orthodoxy and human solidarity, efficiency and equity, markets and people. If there was a problem, it was less about policies than about how little five years of growth changed the three factors that matter most for long-term development — preferences, technologies and resources. Latinos did not begin to save more, pay more taxes, learn more or have more babies. Their industries incorporated few new technologies, created almost no new brands, and gained no global market share — just as it was forty years ago, today only five percent of world trade has a Latin American as a partner. And, except for some energy discoveries and a lot more remitting migrants, the region’s resources did not increase. (See chart 2 in the PDF document uner the photo).



Put it all together and you have a Latin America that did not quite make the most out of the bonanza, but lifted millions out of poverty and has never been better prepared for a crisis. Let alone a monster of a crisis.



STIMULATE WITHOUT DESTROYING



The world will be in recession in 2009, something not seen in generations. Trade and financial flows are falling at stomach-wrenching speed. Many of the institutions that intermediated capital will be out of commission or out of business. Worldwide, some 50 million people will sink into poverty. If everything goes well, global growth may resume in 2010. But, even if it does, Latin America cannot avoid a share of the suffering. On the contrary, its economy will contract by about one percent this year. Six million of its citizens will become poor. And a few of its countries may pay a steep price for skipping homework during the good times.



Beyond a few understandable false starts, the rich world has put forward a plan to deal with the crisis. It is centered on more and faster public expenditure, more money printing, and government ownership (de facto or de jure). That is probably the right answer, given the problem. But is it the right answer for Latin America, too? Not entirely, for the region’s priorities, capacities and strategic position are different.



First, priorities. Latin Americans cannot count on a social insurance system. There is no net to catch them when they fall. Most have no unemployment insurance, and their pension systems cover only a minority of workers. While better social assistance mechanisms were set up in recent years, they are rightly focused on the poor, especially the rural poor, and do not automatically gear up during recessions. This tends to convert temporary economic troubles in the region’s countries into permanent human damage, social unrest, and political melt-downs. By now, the contact points between crises and people are known. Malnutrition, school desertion, and the interruption of basic and preventive health care have accompanied every economic collapse over the past 30 years. Toddlers lost cognitive capacity, teenagers quit the education system, and mortality among the elderly shot up. For Latin America, the first priority now is to avoid all this. The cost is small. And the channels to help are largely in place — from school feeding programs to decentralized budgets for public clinics. It is a question of pumping more resources through those channels before the full force of the crisis hits.



The next question is whether Latin American countries have the capacity to noticeably stimulate their economies, fiscally or monetarily. Not really. Tax cuts would put little money in their people’s pockets, for most pay no direct taxes. Accelerating or increasing public investment would work, if they had the institutional wherewithal to do it — but even the most advanced among them regularly end the year unable to spend their full investment budgets. There is no crowd of investors waiting to buy more government bonds and only one country (Chile) managed to build significant fiscal reserves that can be spent now. Things are only a little bit better on the monetary side. Printing more money to push down interest rates has a limited impact on consumption, for most Latin Americans have no access to credit. Many central banks are either worried about weakening their local currency or simply have no local currency to print (their countries are “dollarized,” like Ecuador, El Salvador and Panama). And, in the end, even with all fiscal and monetary hands on deck, the stimulus will leak. With most of the region’s economies small and open, efforts to stroke demand will actually stroke imports. What will be stimulated is consumption, not necessarily growth.



But the real difference between Latin America and the G7 approach to the crisis goes beyond priorities and capacities. It is strategic. After a decade of effort creating societal consensus around balanced budgets, low inflation, and light debt burdens, is it really smart for the region to burn the policy bridges in the faint hope of smoothing the downturn? The region already experienced unsustainable public spending and run-away money printing (it was not called “quantitative easing” then). It has had governments that owned banks, insurance companies, car companies, and everything else in-between. That was years ago and, as a development strategy, it did not work.

A CRISIS, AN OPPORTUNITY



So, if stimuli will do little for them, are Latin American countries condemned to sit passively through the crisis? Is there anything they can do beyond dodging the immediate human costs? Yes, a lot. In fact, the crisis is an opportunity for the region to position itself as a rising star of the post-crisis world. The key is to use today’s worries to tackle the big issues that have held Latin Americans back — their attitude towards the state, their battles over distribution, their inability to sustain growth over time, and their reluctance to save. At stake are not technicalities, but overdue, fundamental reforms.



The first of those reforms should be a new contract between people and the state. Latin Americans do not trust the state. And because they do not trust it, they refuse to pay for it. Tax collection as proportion of domestic product is about half the European average. Short of money, the state cannot deliver the services in the quantity or quality people want — which feeds the mistrust. This has trapped Latin America in a paralyzing equilibrium whereby people pretend to pay taxes and the state pretends to give services. Efforts to break out of this impasse have mostly focused on fighting corruption, a good cause -- with good initial results. But people do not just care about transparency; they also care about efficacy. They want results. They want to know what exactly will be achieved with every public dollar spent.



Fortunately, the technology to link public action and results has improved over the past decade. Today, we know, for example, how much a properly nourished child should grow in his first year of life (at least 24 centimeters), how fast a second-grader should read (at least 60 words per minute), what should be the logistical cost per every dollar exported (less than ten cents, not the current 25), or what is a “normal” homicide rate (less than 2 per 100,000 people per year, not 20). Indicators like these make it possible for governments to commit to specific results, and be held accountable.



In fact, result-based management is already penetrating Latin America (look among Brazil states), and it is making presidential material of those leaders that adopt it. This will be accelerated by the crisis. As needs increase and resources get scarcer, voters will be willing to pay politically for “good administration.” A virtuous circle of trust and performance could be put in motion. And a major obstacle will have been removed from Latin America’s development path.



Second, an effective state is only as good as the objective it is used for. Latin Americans have never really agreed what the state is for. Some think that the state exists to redistribute wealth, while others think it exists to protect private property. Some speak of the sanctity of justice, others of the sanctity of contracts. Left versus right. Not just across countries, but across governments within countries. Needless to say, the price too often has been a lot less investment and a lot more capital flight. Can the crisis open a door out of this? Yes, it can. Scarcity can help move the debate from inequality of outcomes (such as income) to inequality of opportunity (such as schooling), from equality to equity, from same rewards for all to same chances for all. And once again, new technology comes in handy. Up until last year, measuring inequality of opportunity was all but impossible, which made it all but impossible to do anything about it. That changed in 2008, when a group of researchers published the first Human Opportunity Index (not surprisingly, the first application was on Latin America). (See chart at the bottom).



Now we can design social policy, programs and projects meant to enhance human opportunity. Now we know, for example, that your mother’s education is the single best predictor of whether you will make it in life — more powerful than your gender, skin-color, birthplace, or your father’s income. That monitoring pregnancies and feeding toddlers are great early equalizers. That timely completion of primary school is a pretty accurate predictor of how much you will learn in life, and how employable you will be. That, at the margin, the best we can do for most teenagers is physical security, sexual education, and mentoring. That adults cannot make it if they have no birth certificate, property titles, and voter registration cards — in other words, no civil identity. And we know that giving subsidies to those that do not need them (like free college education for rich students) is an opportunity-wasting aberration. All this could free Latin America of the tension of past debates, for equality of opportunity is a concept dear across the political spectrum — as a matter of justice to the left and as a matter of personal effort to the right.



Third, the crisis could usher a new way not just in social policy. It could also trigger a transformation in the way public investment is done in the region. Back in the early 90s, worried about inflation, Latin American societies took away money printing from their governments’ sources of finance (and gave it to their central banks as a means to keep inflation low). Today, worried about recession, they may take away public investment too. The crisis has brought about a new faith in public works as a growth-generating tool, and the average voter will no longer tolerate that they are cut back to accommodate excesses in current expenditures (things like salaries or administrative costs). This is much more than accounting. It would make it possible for Latin America to have not just “inflation targets” but also “growth targets.” It would give strategic clarity to public investment — its purpose is economic growth, not political reward, regional compensation, or cash management. It would focus attention on faster implementation. It would guide the marginal dollar of public investment to projects that attract the most private partners (they would do the most for growth). It would make the quality of the business environment an issue of fiscal importance (the easier for people to do business, the more effective public investment is). And it would create reserve funds that could be saved when the economy is expected to grow and spent when it is not (stabilization funds, as it were). In short, it would be a way to leave behind the history of wild swings in economic growth.



Finally, the crisis may begin to move one of Latin America’s biggest mountains — its citizens’ reluctance to save. They continue to save the same fifth of their income as they did over the past forty years, a pittance when compared with half in China. The global turmoil may change that. Freshly aware of the few safety nets with which they really count, Latin Americans may at last start to perceive the value of saving. And with foreign financiers out of action, both Latin governments and Latin companies will have a renewed interest in building reliable financial markets at home — markets where people feel confident to invest what they manage to put aside rather than sending it abroad, where anyway its security can no longer be taken for granted. There will be a good platform to start from. The region’s banks have so far escaped much of the fire that engulfed their G7 peers (and, in some cases, owners). Earlier pension reforms, on balance, worked well, even when they highlighted how few people are covered. And political attention to the structure and regulation of finance will peak in the coming years.



THE DAY AFTER TOMORROW



So, as thresholds go, 2009 may be remembered as the year in which Latin America’s latest growth run abruptly ended. Or as the year in which an unprecedented global crisis finally unleashed the region’s potential. Which way it goes will depend on how its policy-makers respond, whether they tailor their reactions to their reality, see the opportunity behind the crisis, and proactively take on the issues that were holding Latin Americans back well before subprime became a household term. Clearly, Latin American problems are not solely economic. The institutions that underpin politics are not fully cemented. Violence and the drugs trade that fuels it have their own dynamics. So have the handful of countries that spent the times of bonanza walking towards the abyss. And nobody knows what development policies will work best in the post-crisis world. But how ironic it would be if a region that could not take off using imported recipes when the world was booming, were to make it on its own terms when the world tumbled.