Mr Ferguson gives a 20-year overview of economic developments in Latin America
Speech by Mr Roger W Ferguson, Jr, member of the Board of Governors of the US Federal Reserve
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 pleasure to
become a member of the roster of Federal Reserve Governors who have addressed this joint meeting
of the Florida International Bankers Association and the Miami Bond Club.
My theme this evening will mirror the fact that international banking has grown significantly in
Florida in the more than 20 years that have elapsed since the passage of the Florida International
Banking Act. Many of you in the audience represent institutions that are active in trade finance
throughout the hemisphere, and there is a natural strong link between Florida and Latin America.
Similarly, about 20 years ago I studied Latin American economic development with Albert O
Hirschman, one of the great development economists of our time. Therefore, the topic I would like
to discuss this evening is what has worked, and apparently has not worked, in Latin America in the
last 20 years or so.
The main message is that, after the 1980s debt crisis, many Latin American countries embarked on a
path of greater economic freedom, lessened government intervention in markets and sounder
policies. Those policies provided the basis for heightened economic dynamism and growth, and
thereby led to significant benefits for their citizens, including higher incomes, lower inflation, and a
wider range of economic opportunities. In view of my audience today, I should also mention that,
partly as a consequence of improved and more market-friendly policies, many of Latin America's
banking systems are endeavoring to become more efficient, more stable, and better integrated with
global financial markets. As a result, Latin American banks should become better able to support the
process of stable, non-inflationary growth in the future. The current economic and financial
problems in Brazil should, if anything, reinforce the importance of pursuing sound fiscal and
monetary policies and improvements in the underlying institutions that support economic activity.
Background
Twenty years ago, or by the end of the 1970s, Latin America was on the verge of moving from a
phase of unsustainable economic activity - based on high domestic consumption, heavy borrowing
from abroad, unsustainable currency levels, and excessive intervention by government in the
economy - into a decade of lost growth and lost opportunities known as the Debt Crisis. As the
1980s began, Latin American countries saw prices of their exports plunge, interest rates skyrocket,
and access to international capital being cut back severely. In this harsh new environment, the
shortcomings of previous policies became even more apparent, and economic performance faltered.
Currency values plummeted as governments ran out of reserves, inflation soared, in some cases to as
much as triple digit levels, and the output of the region contracted severely. Key social and
developmental priorities had to be scaled back as governments struggled to finance their budgets and
find the funds to repay foreign creditors. Domestic financial systems were thrown into disarray and
many banks were severely weakened, both in direct response to the shocks hitting the region, and
also as a result of misguided government policies undertaken in response to economic and political
problems. The main discussions regarding Latin America seemed most focused on issues of
hyperinflation, high unemployment, and repaying the external debt.
Not surprisingly, under these circumstances, job creation during the 1980s was slow, many domestic
businesses did not invest, and direct foreign investment was weak as well. These problems were not
merely the result of uncontrollable, external shocks. They also reflected the fact that many
governments in the region were slow to enact the reforms that would lay the foundation for future
growth. In fact, in many cases governments responded to problems with policies that made things
worse, not better, including wage and price controls, freezes on domestic interest rates, and adoption
of protectionist trade policies. These latter were in some ways particularly problematic, in that Latin
American countries in general did not focus on growing out of their problems through expansion of
foreign trade. Trade flows during the period were relatively small, compared with what one might
expect from economies of their size, and the trade that did occur was highly tilted toward raw
materials and semi-processed industrial products.
In sum, notwithstanding some bright spots, the tone of discussion regarding Latin America seemed
biased toward discussion of problems and not of opportunities.
Current conditions
I cannot say that all of the problems of the late 1970s and 1980s have evaporated. Indeed, as is
illustrated by the current situation in Brazil, there are clearly problems still to be resolved. It
continues to be important for Brazil to implement macroeconomic and structural policies that restore
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 intervening
period, and the region as a whole, even recognizing the ongoing challenges of the current situation,
appears to be closer to achieving the promise that it showed a generation ago. Most of the countries
in the region have experienced growth since the 1980s. Indeed, the growth rate of Latin American
countries has averaged about 31⁄2% annually during this decade.
In addition, the scourge of inflation seems, in general, to have been brought under control. The costs
were high, but the battle seems mainly to have been won. Admittedly, the worst inflation rates, at
about 40%, are still high by the standards in the United States. However, they are much reduced
from those that existed 20 years or even 10 years ago. Last year, Argentina's inflation rate was under
1%. That is down from nearly 5000% in 1989!
Knowing that many of your institutions are involved in trade finance, you know that the trade
outlook for the region has changed significantly from what it was a generation ago. The annual total
merchandise trade of Latin American countries has grown from $130 billion in 1978 to $522 billion
in 1997. Even adjusted for inflation, this represents nearly a doubling of its trade, allowing the
growth of Latin American imports and exports to roughly match the explosion in international trade
experienced throughout the world economy during this period. Moreover, in many Latin American
countries, exports have grown substantially as a proportion of total production, and the fraction of
these exports accounted for by manufactured goods has also increased.
Finally, Latin America has become an active participant in the flow of foreign direct investment and
other forms of capital. In 1990, as the Debt Crisis was winding up, net direct investment flows to
Latin America totaled only $7 billion; by 1997, this figure had risen to $51 billion. Portfolio capital
flows also have grown very substantially. Although they have been more volatile as well, net
portfolio investment rose from $18 billion in 1990 to a peak of about $61 billion in 1993 and 1994,
and were $34 billion in 1997 in the wake of the Asian crisis. Obviously, the current problems
indicate that participation in the global capital markets requires policy discipline and sound
institutional structures, which many countries have put in place and others must continue to develop.
Causes and lessons
As with any macroeconomic performance, there are many causes for the general improvement that
much of Latin America experienced since the 1980s. The most general statement is that many of the
economies of Latin America have adopted more prudent and open policies that foster competition
and participation in global markets. The adoption of these improved policies did not come out of thin
air. They were born out of the disastrous economic performance of the region during the 1980s, and
the realization that only dramatic improvements in economic policies would suffice to allow growth
and prosperity to take hold.
First, there has been a general acknowledgment, and recent reinforcement of the lesson, that prudent
fiscal policy is crucial to economic stability, and several of the economies of the region have made
significant strides in this direction. While much is left to do in this sphere, it does appear that many
countries have learned the benefits of prudent fiscal policy. Fiscal deficits in most countries in the
region have dropped, and in cases where they have not yet declined, serious attention toward
achieving improvements is being mustered. Improvements in budget balances have not been
achieved without pain. In many countries government payrolls have been slashed, generous transfer
and subsidy programs have been cut, and social expenditures have had to be reduced. On the other
hand, the realization has become widespread that in the absence of such budget-cutting measures,
employment and wages would become even more depressed. Moreover, people have found that
many of the actions taken to cut budgets, including privatization of money-losing state enterprises,
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 private
sector prices and wages. It is now widely understood that excessive budget deficits and money
creation are the root causes of inflation, and controls over private prices have been generally
abolished. Governments also have largely scaled back their role in private wage negotiations as well.
Public controls on privately contracted interest rates and other financial market prices also have been
eliminated for the most part. Finally, exchange rates in many Latin American countries have become
more flexible, and where the government still intervenes in foreign exchange markets, there is a
greater understanding that such intervention must be underpinned by appropriate fiscal and monetary
policies.
Third, the role of the government in other aspects of the economy has been substantially diminished,
with an accordingly greater scope allowed for private activity and for competition from abroad.
Internally, many countries have privatized major businesses. The privatization of Telebras, the
Brazilian telephone company, is a prominent recent example, and privatization has proceeded even
further in other Latin American countries. Such privatization has in many cases been complemented
with legislation opening particular sectors to greater and fairer competition. Additionally, trade
barriers have been removed in many countries, often through participation in regional agreements
and broader international arrangements. The trade barriers that have been dismantled include both
tariffs and non-tariff barriers. In consequence, the share of foreign trade in economic activity has
increased substantially in certain cases. Closely associated with increased participation in
international trade has been increased participation in international capital markets, made possible in
part through substantial liberalization of Latin American financial markets.
Finally, in areas where government oversight is important and necessary, progress has been made in
improving supervision and regulation. In particular, effort has focused on strengthening and
modernizing the region's banking sectors, which emerged from the Debt Crisis of the 1980s in a
highly debilitated state. In consequence, banks have gradually risen toward a higher international
standard, assisted in part by an opening of domestic financial sectors to foreign competition and
participation. Measured by various criteria, including capital/asset ratios and loan loss reserves,
banking systems in various Latin American nations are significantly healthier than they were going
into the Debt Crisis. While the region has further to go in strengthening its financial systems, and
important problems remain, the progress achieved to date has been important to the overall recovery
of Latin American economies in the 1990s.
Having said this, Latin America has been affected by some major international financial crises in the
last several years, and obviously Brazil is being affected currently. The lessons to be learned from
these crises remain the subject of strenuous debate; I would offer only the following observations.
First, appropriate and balanced fiscal, monetary, and exchange rate policies continue to matter. The
1994-95 Mexican crisis and the current stresses on Brazil both indicate that markets watch closely
countries that allow imbalances to emerge. In fact, in an era of open capital markets and rapid capital
mobility, the punishment for policy mistakes arguably is even more rapid and severe than have been
the case in the past.
Second, it may not be enough for countries merely to avoid excessive budget deficits or high
inflation. Countries must take steps to reduce their vulnerability to dislocations in the international
financial system, including by raising domestic saving rates, reducing excessive levels of short-term
debt, and increasing the degree of transparency and disclosure both in the public and private sector.
Third, a healthy banking system is an integral part of participation in the modern financial
environment, and also is a particularly important buffer against future financial shocks, both
domestic and external. The question becomes how best to acquire such a system. Some countries
have attempted to maintain a closed national system and build skills at home. Others have opened
their banking market and allowed foreign competition to force the pace of modernization. In
practice, the development of banking sectors is likely to involve some combination of local and
foreign input, although increasingly, countries appear to be finding that foreign involvement
provides important infusions both of expertise and competition. As well, countries are discovering a
strengthening of the systems of banking supervision and regulation to be an indispensable part of the
process of modernizing the financial sector.
Open questions
Many questions about how best to manage economies in an international setting are still open. The
first question is what is the best way to enter the modern world of rapid capital mobility. Foreign
capital obviously can be of tremendous benefit in helping economies to modernize and grow. At the
same time, the tendency of foreign investors to pull their capital out of a country at the same time, as
has recently been observed in various instances throughout the globe, can leave an economy in
serious trouble. How can the benefits of foreign capital flows be retained while their adverse
sideeffects are minimized? Some observers have pointed to the Chilean experience with capital controls.
These controls, which have now been removed, were intended to discourage inflows of short-term
capital, and along with measures to strengthen the banking system, may have helped insulate Chile's
economy from the recent round of financial disturbances. The jury is still out on whether such
controls might be appropriate for other economies. It seems clear that their principal attraction is as a
short-term measure that helps an economy make a full transition to a fully open capital market.
A second question is whether fixed or more flexible exchange rate regimes are more appropriate in
an era of rapid capital mobility. In principle, more flexible exchange rates allow economies to adjust
more easily to changes in international economic and financial conditions, while fixed exchange rate
systems may be useful in instilling a greater degree of discipline on the part of economic
policymakers. In practice, the experience of the past year and a half has taught us that systems in
which exchange rates are only halfheartedly fixed - that is, where fiscal and monetary policies are
not geared toward supporting the currency - are the least sustainable and hence the least desirable.
On the other hand, regimes in which economic policies are rigorously focused on maintaining an
exchange rate peg may still have value in motivating prudent economic policies and in insulating
economies from international financial turbulence. However, fixed rate foreign exchange regimes
and currency boards require considerable internal discipline to work as intended. The benefits are
potentially large, but the effort to maintain such a system and the risks associated with having to
abandon such a system under duress are also large.
Conclusions
To summarize, much of the story of the evolution of Latin American economies in the past decade
has been a story about globalization. Globalization has operated on many different levels to improve
the performance and productivity of the region. However, participation in the global financial market
does, as we have seen, entail risks for countries that have not followed prudent policies. On balance,
globalization clearly has been a strong positive force in the region's economy. Latin America's
economies are sounder, more entrepreneurial, and more dynamic than they have been in many
decades. And yet, grave problems remain. These include widespread poverty, tremendous disparities
in wealth and income, and a level of per capita GDP that in many countries remains little higher than
it was in the early 1980s. I believe that these problems are more likely to be resolved through
continued participation in the global economy than by falling back on earlier models of economic
development.
In closing, since I am speaking to a group of bankers, I would like to reiterate the importance of
good banks and good banking skills in contributing to the economic prospects for the region. By
facilitating trade finance, providing funds for growing companies, and integrating domestic financial
sectors into the global capital market, banks have played a key role in furthering the development of
the Latin American economies. Latin American banking systems, benefiting in large part from rising
levels of foreign participation, are providing increasingly competitive levels of credit and depository
services, thereby laying the groundwork for future dynamism and growth. Healthy banking systems
also are crucial to promoting economic stability. The recent experience of several Asian countries,
where severely weakened banking systems helped contribute to financial crises, has reminded us that
good banking skills and strong bank supervision are indispensable.
Albert Hirschman's wish for Latin American development, which is captured in the title of his book,
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 improvements
in underlying economic and financial institutions.
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