Mr Ferguson gives a 20-year overview of economic developments in Latin America  (Central Bank Articles and Speeches, 11 Feb 99)
Central bank: fed | Type: speech | Date: 1999-02-11

## Mr Ferguson gives a 20-year overview of economic developments in Latin AmericaSpeech by Mr Roger W Ferguson, Jr, member of the Board of Governors of the US Federal Rese System, to the Florida International Bankers Association in Miami on 11/02/99.Thank you very much for inviting me to join you this evening here in Miami.

It is a pl become a member of the roster of Federal Reserve Governors who have addressed this joint m of the Florida International Bankers Association and the Miami Bond Club.My theme this evening will mirror the fact that international banking has grown signifi Florida in the more than 20 years that have elapsed since the passage of the Florida In Banking Act.

Many of you in the audience represent institutions that are active in tra throughout the hemisphere, and there is a natural strong link between Florida and Latin Similarly, about 20 years ago I studied Latin American economic development with Albe Hirschman, one of the great development economists of our time.

Therefore, the topic I wo to discuss this evening is what has worked, and apparently has not worked, in Latin Ameri last 20 years or so.The main message is that, after the 1980s debt crisis, many Latin American countries embar path of greater economic freedom, lessened government intervention in markets and so policies.

Those policies provided the basis for heightened economic dynamism and growth thereby led to significant benefits for their citizens, including higher incomes, lower in wider range of economic opportunities.

In view of my audience today, I should also menti partly as a consequence of improved and more market-friendly policies, many of Latin Ame banking systems are endeavoring to become more efficient, more stable, and better integra global financial markets.

As a result, Latin American banks should become better able to su process of stable, non-inflationary growth in the future.

The current economic and problems in Brazil should, if anything, reinforce the importance of pursuing sound fi monetary policies and improvements in the underlying institutions that support economic act

## BackgroundTwenty years ago, or by the end of the 1970s, Latin America was on the verge of moving phase of unsustainable economic activity - based on high domestic consumption, heavy borr from

abroad, unsustainable currency levels, and excessive intervention by government economy - into a decade of lost growth and lost opportunities known as the Debt Crisis. 1980s began, Latin American countries saw prices of their exports plunge, interest rates and access to international capital being cut back severely.

In this harsh new enviro shortcomings of previous policies became even more apparent, and economic performance falt Currency values plummeted as governments ran out of reserves, inflation soared, in some cas much as triple digit levels, and the output of the region contracted severely.

Key developmental priorities had to be scaled back as governments struggled to finance their bu find the funds to repay foreign creditors.

Domestic financial systems were thrown into di many banks were severely weakened, both in direct response to the shocks hitting the reg also as a result of misguided government policies undertaken in response to economic and problems.

The main discussions regarding Latin America seemed most focused on issues hyperinflation, high unemployment, and repaying the external debt.Not surprisingly, under these circumstances, job creation during the 1980s was slow, many businesses did not invest, and direct foreign investment was weak as well.

These problems merely the result of uncontrollable, external shocks.

They also reflected the fact governments in the region were slow to enact the reforms that would lay the foundation f growth.

In fact, in many cases governments responded to problems with policies that madeworse, not better, including wage and price controls, freezes on domestic interest rates, of protectionist trade policies.

These latter were in some ways particularly problematic, American countries in general did not focus on growing out of their problems through expan foreign trade.

Trade flows during the period were relatively small, compared with what o expect from economies of their size, and the trade that did occur was highly tilted t materials and semi-processed industrial products.In sum, notwithstanding some bright spots, the tone of discussion regarding Latin America biased toward discussion of problems and not of opportunities.

## Current conditionsI cannot say that all of the problems of the late 1970s and 1980s have evaporated.

Ind illustrated by the current situation in Brazil, there are clearly problems still to b continues to be important for Brazil to implement macroeconomic and structural policies th international confidence and also reassure citizens that inflation will not reignite.However, much does seem to have changed with respect to Latin America during the interve period, and the region as a whole, even recognizing the ongoing challenges of the current appears to be closer to achieving the promise that it showed a generation ago.

Most of the in the region have experienced growth since the 1980s.

Indeed, the growth rate of Latin countries has averaged about 3½% annually during this decade.In addition, the scourge of inflation seems, in general, to have been brought under contro were high, but the battle seems mainly to have been won.

Admittedly, the worst inflation about 40%, are still high by the standards in the United States.

However, they are much from those that existed 20 years or even 10 years ago.

Last year, Argentina's inflation rat 1%.

That is down from nearly 5000% in 1989!Knowing that many of your institutions are involved in trade finance, you know that t outlook for the region has changed significantly from what it was a generation ago.

The an merchandise trade of Latin American countries has grown from $130 billion in 1978 to $522 in 1997.

Even adjusted for inflation, this represents nearly a doubling of its trade, growth of Latin American imports and exports to roughly match the explosion in internation experienced throughout the world economy during this period.

Moreover, in many Latin Amer countries, exports have grown substantially as a proportion of total production, and the these exports accounted for by manufactured goods has also increased.Finally, Latin America has become an active participant in the flow of foreign direct inve other forms of capital.

In 1990, as the Debt Crisis was winding up, net direct investmen Latin America totaled only $7 billion; by 1997, this figure had risen to $51 billion.

Port flows also have grown very substantially.

Although they have been more volatile as we portfolio investment rose from $18 billion in 1990 to a peak of about $61 billion in 1993 and were $34 billion in 1997 in the wake of the Asian crisis.

Obviously, the current indicate that participation in the global capital markets requires policy discipline institutional structures, which many countries have put in place and others must continue t

## Causes and lessonsAs with any macroeconomic performance, there are many causes for the general improvement much of Latin America experienced since the 1980s.

The most general statement is that many economies of Latin America have adopted more prudent and open policies that foster compe and participation in global markets.

The adoption of these improved policies did not come o air.

They were born out of the disastrous economic performance of the region during the 19the realization that only dramatic improvements in economic policies would suffice to allo and prosperity to take hold.First, there has been a general acknowledgment, and recent reinforcement of the lesson, th fiscal policy is crucial to economic stability, and several of the economies of the regio significant strides in this direction.

While much is left to do in this sphere, it does a countries have learned the benefits of prudent fiscal policy.

Fiscal deficits in most cou region have dropped, and in cases where they have not yet declined, serious attention achieving improvements is being mustered.

Improvements in budget balances have not b achieved without pain.

In many countries government payrolls have been slashed, generous t and subsidy programs have been cut, and social expenditures have had to be reduced.

On th hand, the realization has become widespread that in the absence of such budget-cutting m employment and wages would become even more depressed.

Moreover, people have found tha many of the actions taken to cut budgets, including privatization of money-losing state e has led to better service and an improved quality of life.Second, there has been a substantial dismantling of the controls imposed by government over sector prices and wages.

It is now widely understood that excessive budget deficits an creation are the root causes of inflation, and controls over private prices have bee abolished.

Governments also have largely scaled back their role in private wage negotiation Public controls on privately contracted interest rates and other financial market prices al eliminated for the most part.

Finally, exchange rates in many Latin American countries have more flexible, and where the government still intervenes in foreign exchange markets, t greater understanding that such intervention must be underpinned by appropriate fiscal and policies.Third, the role of the government in other aspects of the economy has been substantially d with an accordingly greater scope allowed for private activity and for competition from Internally, many countries have privatized major businesses.

The privatization of Tele Brazilian telephone company, is a prominent recent example, and privatization has proceed further in other Latin American countries.

Such privatization has in many cases been compl with legislation opening particular sectors to greater and fairer competition.

Additio barriers have been removed in many countries, often through participation in regional ag and broader international arrangements.

The trade barriers that have been dismantled inc tariffs and non-tariff barriers.

In consequence, the share of foreign trade in economic increased substantially in certain cases.

Closely associated with increased partic international trade has been increased participation in international capital markets, mad part through substantial liberalization of Latin American financial markets.Finally, in areas where government oversight is important and necessary, progress has been improving supervision and regulation.

In particular, effort has focused on strengthe modernizing the region's banking sectors, which emerged from the Debt Crisis of the 198 highly debilitated state.

In consequence, banks have gradually risen toward a higher int standard, assisted in part by an opening of domestic financial sectors to foreign compe participation.

Measured by various criteria, including capital/asset ratios and loan lo banking systems in various Latin American nations are significantly healthier than they w into the Debt Crisis.

While the region has further to go in strengthening its financial important problems remain, the progress achieved to date has been important to the overall of Latin American economies in the 1990s.Having said this, Latin America has been affected by some major international financial cri last several years, and obviously Brazil is being affected currently.

The lessons to be these crises remain the subject of strenuous debate; I would offer only the following obFirst, appropriate and balanced fiscal, monetary, and exchange rate policies continue to 1994-95 Mexican crisis and the current stresses on Brazil both indicate that markets watc countries that allow imbalances to emerge.

In fact, in an era of open capital markets and r mobility, the punishment for policy mistakes arguably is even more rapid and severe than h the case in the past.Second, it may not be enough for countries merely to avoid excessive budget deficits inflation.

Countries must take steps to reduce their vulnerability to dislocations in the financial system, including by raising domestic saving rates, reducing excessive levels of debt, and increasing the degree of transparency and disclosure both in the public and privaThird, a healthy banking system is an integral part of participation in the modern environment, and also is a particularly important buffer against future financial sh domestic and external.

The question becomes how best to acquire such a system.

Some cou have attempted to maintain a closed national system and build skills at home.

Others hav their banking market and allowed foreign competition to force the pace of modernizat practice, the development of banking sectors is likely to involve some combination of l foreign input, although increasingly, countries appear to be finding that foreign in provides important infusions both of expertise and competition.

As well, countries are dis strengthening of the systems of banking supervision and regulation to be an indispensable p process of modernizing the financial sector.

## Open questionsMany questions about how best to manage economies in an international setting are still o first question is what is the best way to enter the modern world of rapid capital mobil capital obviously can be of tremendous benefit in helping economies to modernize and grow. same time, the tendency of foreign investors to pull their capital out of a country at the has

recently been observed in various instances throughout the globe, can leave an eco serious trouble.

How can the benefits of foreign capital flows be retained while their a effects are minimized?

Some observers have pointed to the Chilean experience with capital These controls, which have now been removed, were intended to discourage inflows of shor capital, and along with measures to strengthen the banking system, may have helped insulate economy from the recent round of financial disturbances.

The jury is still out on whe controls might be appropriate for other economies.

It seems clear that their principal attr short-term measure that helps an economy make a full transition to a fully open capital marA second question is whether fixed or more flexible exchange rate regimes are more approp an era of rapid capital mobility.

In principle, more flexible exchange rates allow economi more easily to changes in international economic and financial conditions, while fixed exc systems may be useful in instilling a greater degree of discipline on the part of policymakers.

In practice, the experience of the past year and a half has taught us that which exchange rates are only halfheartedly fixed - that is, where fiscal and monetary po not geared toward supporting the currency - are the least sustainable and hence the least On the other hand, regimes in which economic policies are rigorously focused on maintain exchange rate peg may still have value in motivating prudent economic policies and in in economies from international financial turbulence.

However, fixed rate foreign exchange and currency boards require considerable internal discipline to work as intended.

The be potentially large, but the effort to maintain such a system and the risks associated wi abandon such a system under duress are also large.

## ConclusionsTo summarize, much of the story of the evolution of Latin American economies in the past has been a story about globalization.

Globalization has operated on many different levels the performance and productivity of the region.

However, participation in the global financ does, as we have seen, entail risks for countries that have not followed prudent policies. globalization clearly has been a strong positive force in the region's economy.

Latin economies are sounder, more entrepreneurial, and more dynamic than they have been in decades.

And yet, grave problems remain.

These include widespread poverty, tremendous disp in wealth and income, and a level of per capita GDP that in many countries remains little h it was in the early 1980s.

I believe that these problems are more likely to be resolv continued participation in the global economy than by falling back on earlier models of development.In closing, since I am speaking to a group of bankers, I would like to reiterate the im good banks and good banking skills in contributing to the economic prospects for the re facilitating trade finance, providing funds for growing companies, and integrating domesti sectors into the global capital market, banks have played a key role in furthering the dev the Latin American economies.

Latin American banking systems, benefiting in large part from levels of foreign participation, are providing increasingly competitive levels of credit a services, thereby laying the groundwork for future dynamism and growth.

Healthy banking sy also are crucial to promoting economic stability.

The recent experience of several Asian where severely weakened banking systems helped contribute to financial crises, has reminded good banking skills and strong bank supervision are indispensable.Albert Hirschman's wish for Latin American development, which is captured in the title of h A Bias for Hope:

Essays on Development and Latin America , may eventually be fulfilled if the region stays the course and pursues sound fiscal and monetary policies and the needed impro in underlying economic and financial institutions.