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Frenkel, Roberto. MACROECONOMIC SUSTAINABILITY AND DEVELOPMENT PROSPECTS:

THE LATIN AMERICAN PERFORMANCE IN THE NINETIES. CEDES, Buenos Aires, Argentina. 1995. p. 92. (Economía: Nº 111) Disponible en la World Wide Web: http://bibliotecavirtual.clacso.org.ar/ar/libros/argentina/cedes/frenkel3.rtf






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Documento CEDES/111

Serie Economía


MACROECONOMIC SUSTAINABILITY AND DEVELOPMENT PROSPECTS:

THE LATIN AMERICAN PERFORMANCE IN THE NINETIES


Roberto Frenkel


El Area de Economía del CEDES agradece el apoyo a la investigación de UNCTAD, del IDRC (Canadá), la SAREC (Suecia), la Mellon Foundation (Estados Unidos) y la Universidad de La Plata (Argentina).


CEDES

Buenos Aires, 1995

Macroeconomic Sustainability and Development Prospects:

the Latin American Performance in the Nineties1


1. The nineties Latin American performance and the Mexican crisis.


Since the beginning of the nineties Latin America has shown indications of recovery from the generalized crisis of the previous years. There has been a marked decline in the rate of inflation and a recovery of positive rates of growth. Until mid-1994, the megainflationary process in Brazil placed this country outside the above-mentioned trends and so, given the significant relative weight of the country in the region, made the general characterization dubious. But the "Plano Real", the stabilization program launched in July 1994 and still successful in both the inflation and activity level fronts, has brought Brazil's macroeconomic performance up to the average of the rest of the main countries.

Paradoxically, a few months after Brazil began to perform like its well-behaved neighbors, some of these showed renewed symptoms of instability and the need for another round of external adjustment. The Mexican crisis marks the clear end of the early nineties, a period characterized by the above-mentioned trends. This seems to be so not only because of the significant regional weight of Mexico but also because other factors enhance its importance beyond its demographic and economic relative weight.

Despite the fact that both Brazil and Mexico are the largest countries in the region, there is a substantial difference between Brazilian instability, recently overcome, and Mexican instability, recently reopened. While the Brazilian instability was seen as an enduring symptom of the eighties, awaiting a definitive solution, the Mexican crisis represents the emergence of instability and uncertainty in a country that was supposed to have left these symptoms definitively behind. The Mexican crisis symbolizes, in this sense, a turning point for Latin America as a whole because Mexico actually led the regional process of stabilization and structural reform and was held up as an example for other countries to follow. The country was not only the benchmark with regard to fiscal discipline, privatization and deregulation, but its experience was also supposed to lead - through the NAFTA agreement - a regional path of beneficial growing trade integration with the USA.

Other factors also contribute to spreading the meaning and effects of the Mexican events. Mexico's performance plays a leading role in the formation of the international investors' expectations about Latin America as a whole. Then, independently of the actual similarities between the individual situations in the region, bandwagon expectations exert a generalized effect on capital flows. In countries like Argentina, where macroeconomic configuration resembles in many aspects the Mexican pre-crisis situation, reduced capital inflows have a self-fulfilled impact on the country's performance. But, to a different extent and with different consequences, the "herd behavior" of international capital flows will surely effect every country in the region.

Beyond any speculation about future prospects, the Mexican crisis has already had a significant impact on the region, as can be seen through the immediate reaction of the Latin American international bonds and domestic stock prices. Moreover, the broad character of the acknowledgment of the generalized effects of the Mexican crisis can be stressed by mentioning that they constituted the main foundation of the rescue package promoted by the American government.

For many analysts, both the Mexican crisis and its present and future probable regional consequences were not unexpected. This is not to say that the December 20 devaluation and the following episodes were predicted in detail, but that the increasing dependence on short-run capital inflows to finance rising trade and current-account deficits made the medium-run unsustainability of that process clear. For instance, in the 1993 UNCTAD Trade and Development Report it was asserted that in the cases of Mexico and Argentina "even though autonomous capital flows have so far been more than enough to finance external deficits, these countries need to undertake an external adjustment through higher investment and exports. If the opportunities for an expansionary adjustment are not exploited, deflationary adjustment may eventually become unavoidable." The rationale behind this expectation was the low probability attributed to a permanently increasing amount of capital inflows, in conjunction with the trends exhibited by the external accounts. If, as was expected, net capital inflow falls at some point below the financial needs of the current account, reserves will start to decline. The reserves reduction, through its direct effects on money and credit and by pushing the domestic rate of interest up - automatically or as a policy reaction intended to attract foreign capital - will induce recession and might ultimately lead to a run, forcing a devaluation. Actually, trade-and current-account deficits continued growing in Mexico and Argentina in 1994. In Argentina, the reserves stagnated in the first part of the year and declined afterwards, moderately before the Mexican crisis and more rapidly afterwards. In Mexico, the reserves stood at $29 billion in February 1994, when American monetary policy started to raise the interest rates. From then on, Mexico lost reserves throughout the year and at a faster rate just before and after the devaluation. By December 22, reserves were down to $6 billion and the authorities left the currency to float. In all of 1994 reserve losses amounted to $20 billion, while the current account showed a $30.6 billion deficit. This means that net capital inflows in 1994 were about $10 billion, one-third of the almost $30 billion that Mexico received in 1993.

In 1993 Mexico and Argentina showed the worst regional indicators of external fragility and their external trends pointed to a future turning point, some changes in policy and some kind of reversion of the early nineties performances. But afterwards, in 1994 and before the Mexican devaluation, some new elements emerged in the regional performance that represented, in fact, the first symptoms of a turning point. One of them was the above-mentioned new trend of the international reserves in Mexico and Argentina. The starting point of the process was February 1994, when the American Federal Reserve began to increase the short-term rate of interest.

From February on, against conventional expectations, the prices of long-term bonds fell and long-term interest rates went up together with the short-term rates. Both movements had a more than proportional impact on Latin American bond prices and lending interest rates. Simultaneously with the rise in short and long-term American interest rates, there was a generalized increment in the Latin American country risk spreads charged to the region. This can be seen in Tables 5 and 6. The tables show that in 1994, before the Mexican crisis, the spreads of long-term bonds on US Treasury bills augmented very significantly. These facts should be stressed because they represent the first negative2 international markets herd behavior with regard to the region in the nineties.

Under what circumstances should country risks rise when American interest rates go up? Only if international investors get a perception of the regional external fragility and of the negative impact that higher international rates would have on it. But, by asking for higher compensatory risk spreads, the financial markets' behavior accentuates that negative effect. So, it was not necessary to wait until Mexico devalued to see evidence of self-fulfilling prophecy behavior regarding Latin America. While the Mexican crisis coordinated that behavior at the end of the year, a similar coordination was provided throughout 1994 by the rising American rates of interest. In this sense, the Mexican crisis can be interpreted as a specific episode following a period of financial distress that started at the beginning of the year. As we argued above, the episode itself is showing a significant feed-back effect on the whole region. The sequence is far from new. The analogy with the late seventies-early eighties is apparent, but, more generally, the sequence of a financial boom, followed by a period of distress and a final abrupt contraction, reproduces accurately the phases of a Minskyan financial crisis.

There are also other elements in the 1994 financial markets that complement the above-mentioned evidence. During the year and before the Mexican crisis, individual country risk spreads seem to have risen in correlation with the relative external fragility indicators, less in the cases of Chile and Colombia and more in the cases of Mexico and Argentina. This "revealed attitude" of the financial investors regarding the relative external fragility of individual countries is consistent with the mentioned attitude towards Latin America as a whole, and also with our hypothesis about the main sources of the perceived risk.

It should be stressed that the markets' "revealed perceptions" were in conflict with the judgments made public by some international financial institutions, such as the IMF and the World Bank. According to these official points of view, risks could only emerge from an undisciplined fiscal performance or from threats to the persistence of the structural reforms. Because none of these conditions applied in the cases of Mexico and Argentina, both countries ranked in the lower risk category.

The Mexican crisis and its immediate consequences should have a significant impact on the theoretical views about stabilization and development and on their policy implications. From the official point of view of the IMF and the World Bank, the Mexican crisis should never have happened. Although we can take for granted that some ad hoc explanations will be found in order to save political positions and theoretical principles from the effects of empirical evidence, this time it will be a very difficult task.

As we mentioned above, international financial crises are not new and the essential features of the early nineties cycle resembles that of the late seventies-early eighties. In particular, there is a marked analogy between the recent and present Mexican evolution and the Chilean early eighties case. Nevertheless, after the debt crisis, theoretical principles were saved by ascribing the debt crisis to fiscal deficits and ISI. Brazil, Mexico and Argentina were exemplary cases in this regard. The Chilean case did not fit into that diagnosis well, and that is why its early eighties external and financial crisis was rarely mentioned or analyzed.

Regarding the possibilities of developing an analogous ideological operation, the present situation differs in some important aspects. Firstly, the crisis directly involves the most important, exemplary and leading country regarding orthodoxy and free market structural reform. Secondly, many countries in the region have strictly followed the same policy prescriptions, particularly Argentina, which is the second most affected economy. Thirdly, there has been considerable direct public involvement of the American administration in the evolution of the Mexican economy since well before the crisis, not only through the NAFTA agreement and the inclusion of Mexico in OECD, but also through the swaps agreements signed in 1993 and 1994. Fourthly, although the IMF expressed the same opinion and optimistic judgments about the Chilean economy in 1981 that the institution expressed recently about Mexico, the IMF and the World Bank seem never to have been so committed to an individual country's performance as they are now to Mexico's.

All of these circumstances help to explain the extraordinary characteristics of the rescue package promoted by the American administration and the IMF. But the operation itself represents a severe shock to the prevailing ideas. The theoretical basis of current policy orientations, particularly regarding financial markets deregulation and opening, assumes rational expectations agents behavior and market with self-stabilizing properties. After years of advocating against public intervention and regulation on that basis, the calls for a massive public rescue package seem rather pathetic. So, even if the rescue package serves its intended purpose to avoid the worst immediate consequences of the Mexican crisis and allows the financial markets to stabilize for some time, the lack of consistency of the ideas that founded the model have been irremediably exposed.


2. The macroeconomic sustainability and the long-term development aspects of the early nineties performances.


The main purpose of this paper is to evaluate the trends in the nineties as they evolved up until the Mexican crisis, and to discuss its prospects. The discussion of the economic prospects should focus both on the observed trends and on the probable effects of the Mexican crisis, not only on Mexico itself but also on other countries.

It is possible to talk about the regional performance because the countries' individual performances have some common aspects and share some common external influences. Some have been pointed out above. But the countries differ in other aspects that are crucial for our purposes. To pay the necessary attention to this diversity we have chosen five countries we think represent three different stylized patterns: Argentina and Mexico, Chile and Colombia, and Brazil. It should be mentioned that beyond their capacity to illustrate these patterns, these countries also make up a representative sample of the region given their economic and demographic weight.

Our evaluation of these cases intends to focus on two issues. The first is the sustainability of the recent macroeconomic trends from a macroeconomic point of view. The second is the long-term development aspects of the recent growth performance. The first issue relates mainly to questions regarding the fragility of macroeconomic equilibria vis-à-vis plausible changes in external and domestic conditions. The second intends to tackle a more difficult question. To what extent is it possible to assume that the positive rates of growth that most of the countries have been experiencing - some of them only recently, like Argentina, but others, like Chile and Colombia, since the mid-eighties - represent the first stage of a self-sustaining and lasting development process?

Let us try to determine the meaning and limits of these analytical perspectives. In principle, it seems difficult to distinguish clearly one from the other. For example, macroeconomic sustainability refers to the conditions that should be fulfilled in order to give a lasting character to low inflation and positive rates of growth. But, at the same time, these conditions seem to be necessary for long-term development, as was illustrated by the impressive evidence provided by the "lost decade." On the other hand, lasting positive growth rates, as an essential ingredient of macroeconomic sustainability, will require, aside from other conditions, rates of investment in physical and human capital which suffice to assure a compatible growth of productive capacity. Then, in thinking of sustainable rates of growth, the analysis enters the core of the long-term development process. So, without going any further it is easy to see that both perspectives, in a broad sense, overlap substantially. However, we think that the distinction can be analytically fruitful if the issues are narrowed to focus on the main questions posed by the actual situation of the countries.

The advantage of this distinction is that it takes into account the special way in which economists view the country experiences. Certainly this is not the best, but it is a fact that there are two differentiated bodies of analysis and specific questions, regarding stabilization and macroeconomic equilibrium, on the one hand, and development on the other. So, differentiating the analyses makes it easier to anchor the discussion in the current debates on stabilization and development.

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