POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise APRIL 2010 · Number 10 54182 A Brave New World for Latin America Marcelo M. Giugale With variations across countries, Latin America's economic agenda will change over the next few years. Fiscal policy will be monitored more independently, and may lean more against cycles. Financial regulation will be heavier, and less attuned with a single international model. Innovation will be at the center of trade strategies. Equity will begin to replace equality as the driver of social programs. More state agencies will be managed by results, starting the long process of earning citizens' trust. The region will play a larger global role, led by Brazil. And if the world's economy holds, most Latin Americans will be on a faster development path. Introduction and Summary a changing regulatory wisdom in finance; the shifting of so- cial policy from equality to equity; the use of results to re- In 2009, Latin America dodged a bullet. Its efforts over the build trust in the state; and the realities of having a bigger previous decade at better economic management and smarter role in world affairs. social policy paid off, and the worst global recession in a gen- Not all Latin American countries will move along the eration caused only minor damage. Does this mean that the new agenda at the same speed. A few have already started, region will go back to business as usual, back to a commodity- and a few may even go for a while in an opposite direction. fueled bonanza, back to la vida loca? No, it doesn't. The crisis Overall, however, the picture that emerges is one of second- has opened challenges that our policy makers will be forced generation policies, a reflection of well-managed economies to address, and opportunities they will be foolish to ignore. making the most of a promising development horizon. This report describes those challenges and opportunities, and uses them to visualize how the region's economic policy Independent Fiscal Agencies agenda will change over the coming years. It does not focus on all the issues that will be relevant, but on those that will The crisis has shown the wisdom of governments that save be relevant and different.1 Specifically, it will argue that six in good times to spend more during downturns--the wis- new issues will appear on the radar of Latin American policy dom of "countercyclical fiscal policy."2 That simple principle makers: fiscal decision making that smoothes, rather than brought huge economic and political rewards to those that exacerbates, business cycles; a profound preoccupation with practiced it (for example, Chile). But it did more than that. innovation as a means to commercial survival; adaptation to It opened the door to a new way of thinking about public 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise finance. Much as in the early 1990s when worries about in- or exporting from, places like Bogotá, Lima, São Paulo, or flation led many Latin American countries to stop printing Santiago will be more expensive in U.S. dollars. It will be money to pay for fiscal deficits and to shift control of the more difficult to sell our products in the United States and printer to an independent central bank, worries about un- in any other country that keeps its currency tied to the U.S. employment may now lead them to link taxation and public dollar (notably, China). That is why success in trade will now investment to growth. In the 1990s, half a dozen of our depend more on new products. Although getting additional countries adopted "inflation targets," and met them. The free trade agreements will still be good, creating new brands times for more independent fiscal decisions that take into will be even better. account "growth targets" cannot be too far away. The problem for Latin America is that, on the whole, it Will independent fiscal agencies become common in has not excelled at innovation. It invests too little in research Latin America? Probably. But they will have advisory rather and development, provides few tax incentives, does not pro- than decision-making, roles. That is, they will be fiscal "coun- tect intellectual property well, and has universities that are cils" rather than fiscal "authorities." In fact, a couple of coun- disconnected from its businesses. This is reflected in minute cils already exist (Brazil, Chile), mostly in the form of levels of patent registration, declining total factor produc- technical support for parliaments. As more countries in the tivity (relative to the U.S. benchmark), few firms acquiring region implement "fiscal frameworks" or "fiscal responsibility quality certifications (less than a quarter), and a commercial laws" (and 10 already have), independent monitoring will penetration that has been stagnant for decades (only about become a necessity--both to judge the realism of budget 5 percent of world trade has a Latin American as partner) projections and to hold government's accountable during (figure 1). Even the precrisis years of abundant financing execution. To some extent, private organizations (for-profit saw only a handful of new Latin American business lines and not-for-profit) have been providing that kind of moni- come to market--premium foods, medical tourism, aero- toring service for a while. As pressures mount for fiscal pol- nautic engineering, software development, and call centers. icy to be (and be perceived to be) countercyclical, the role It will take years to fix those problems, but the new global of fiscal watchdog will become institutionalized within the reality will make change unavoidable. Will there be a single apparatus of the state, but outside the control of incumbent formula to foster innovation in Latin America? No. Our governments. countries differ in terms of technological stock, efficacy of There may be an additional force pushing for independ- tax systems, quality of human capital, legal predictability, ent fiscal opinions: the continuing accumulation of com- and institutional capacity. But successful innovation strate- modity-related revenues. In the baseline global scenario, gies show some common features that point the way for- growth in Asia will keep commodity demand strong and ward: they are priorities of the state (they do not change commodity prices high. Volumes may also increase, driven from government to government); they are not based solely by recent discoveries of oil and gas (Brazil, Colombia). This on markets; all relevant stakeholders are engaged (big and will translate into fiscal abundance for many Latin American small, public and private); somebody is accountable for re- countries. In that event, some of those monies will have to sults; they are part of a broader effort of integration; they be saved in sovereign wealth funds, whose rules of operation are well funded; they are continuously evaluated and ad- will be the subject of much debate. Having independent justed; they begin with quick wins (usually in the area of agencies monitor the application of those rules and, at times, quality standards); they include reforms in tertiary educa- provide technical input (for example, in forecasting prices) tion; and they operate within a reliable legal framework. will become a more accepted practice--and a way to avoid It is interesting to note that more private innovation in political meddling. Latin America will call for better public action. From ven- ture funding to skill improvement, the state will have a new Innovate or Perish role to play. Rather than taking the exclusive leadership as it tried in the past (with poor results), it will become a cat- Successful Latin American countries will have to learn to live alyzing partner in multiagent efforts. In some cases, it will with appreciated currencies. With interest rates in the devel- contribute resources; in others, it will contribute reforms. oped world likely to stay floor-low for a while, money will continue to flow into the region's more promising economies. Reinventing Finance This will make them less competitive. There is not much they can do about it--accumulate reserves, impose capital We will be wary of fancy finance. Our banks and bourses controls and taxes, keep banks from credit sprees, increase sailed through the crisis rather well. There were no subprime productive efficiency. But those are either unsustainable surprises in Latin America. In part, that is because our finan- measures or long-term reforms. The reality is that living in, cial sectors are small, unsophisticated, and with limited ex- 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 1. Symptoms of Innovation, or Lack of It a. Commercial penetration b. Output per worker percentage of world commerce ratio over time 25 0.5 0.4 20 0.3 15 0.2 10 19 0 19 2 19 4 19 6 19 8 19 0 19 2 19 4 19 6 20 8 20 0 20 2 20 4 20 6 20 8 20 0 20 2 14 8 8 8 8 8 9 9 9 9 9 0 0 0 0 0 1 1 19 5 year 0 Asia Latin America 19 0 19 2 19 4 19 6 19 8 19 0 19 2 19 4 19 6 20 8 20 0 20 2 20 4 20 6 20 8 20 0 20 2 14 8 8 8 8 8 9 9 9 9 9 0 0 0 0 0 1 1 19 Source: World Bank staff calculations and projections, based on Heston, year Summers, and Aten (2006). Note: The chart shows the output per worker as a ratio of the U.S. output Asia Latin America per worker over time. The Latin America aggregate is calculated as the unweighted average of Argentina, Brazil, Chile, Colombia, Costa Rica, Source: World Bank staff calculations and projections, based on Ecuador, Mexico, Peru, Uruguay, and República Bolivariana de Venezuela. International Monetary Fund (World Economic Outlook) data The Asia aggregate is calculated as the unweighted average of China; Hong Note: Commercial penetration is defined as exports plus imports as a Kong, China; India; Indonesia; Republic of Korea; Malaysia; Singapore; percentage of world commerce. Taiwan, China); and Thailand. c. Patents, 2007 d. R&D expenditure 160 5.0 patents per 1,000 R&D researchers expenditure (% of GDP) ISR 140 4.0 SWE 120 JPN FIN KOR 3.0 100 80 2.0 CHN NZL 60 1.0 IND BRA CHL ARG MEX 40 COL VEN 0 20 0 0 00 00 00 00 00 00 00 00 00 00 ,0 ,0 ,0 ,0 ,0 ,0 ,0 ,0 ,0 5, 10 15 20 25 30 35 40 45 50 0 Ch na N R an re J .S. rm ds ed d De apo . Co Bra o ge bia Ko Ca any Si U n zu w lay k C e lo zil Ge lan f , C da nm re B. d M hile Fi hina a, al a a ng .K r o ne Ne Ma ar d ic in el Ze si Sw lan e R. an i a, ap he . ng na U ex nt Ar m et ep GDP per capita (2007 current US$) n Ko Source: World Bank staff calculations, based on World Bank data. g on H Note: The chart shows the relationship between R&D expenditure as a Ve economy percentage of GDP and the GDP per capita. Source: World Bank staff calculations, based on World Intellectual Property Organization and World Bank data. Note: R&D = research and development. The chart shows the number of patents in the United States per 1,000 researchers in research and bankers should be paid, and from who is "too big to fail" to development. how savers should be protected, it is all up for discussion. Over the next couple of years, governments in our region will have to decide how much of the new thinking to adopt, ternal connections; and, in part, because we still regulate adapt or avoid. them in a heavy-handed, old-fashioned way. On top, our re- In practice, regional policy makers will be dealing with fi- maining publicly owned banks came in handy to keep credit nancial issues at both ends of the technical spectrum. On the flowing. Meanwhile, the developed world, shocked by the one hand, postcrisis second-generation questions will have to excesses on Wall Street, entered a wide debate about new be addressed--countercyclical regulation, systemic risk, and ways to control financiers without killing their creativity. nonbank intermediaries. On the other hand, a long list of From how much capital banks should hold to how much basic but critical matters that preceded the crisis remains 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise pending, especially in terms of competition and efficiency, Figure 2. Gini Coefficients before and after Public Transfers, access by the poor, and underdeveloped equity markets. circa 2006 That policy dichotomy will play out at a time when Latin 60 America's financial sector will be under pressure. In the 50 short-term, and as described earlier, foreign capital inflows Gini coefficient will be abundant. Much of these inflows will be reflected in 40 excess liquidity among domestic banks and in larger domes- tic lending. Some will flow into the regional equity markets, 30 which (given their relatively small size) may quickly expe- 20 rience a surge in prices. In both cases, the domestic financial sector will be exposed to sudden capital flow reversal. Reg- 10 ulating this risk away will not be easy. A different challenge emerges in the medium term. The 0 a d e y in n an n anc an pa ede . il le o ru ly OE U CD M ia region's largest countries are expected to continue experi- in .K az ic nt Ita Co Chi b E Pe a a U ex m m S w ic bbe Fr er Br ge lo encing surpluses in their balance of payments' current ac- Ar er ri G .S a .S Am C U counts, led by high commodity prices. The counterpart of tin the La those surpluses--large domestic savings--will need to be in- country/region termediated. In other words, the balance sheet of Latin before after America's financial system will expand considerably. Whether this fosters consumption or investment, at home Source: World Bank staff calculations, based on World Bank and OECD data. or abroad, by the public or by the private sector, will depend Note: EU = European Union; OECD = Organisation for Economic Co-opera- on the regulatory parameters under which the system is tion and Development. made to operate. In the recent past, markets could be relied on to set some of those parameters (for example, through credit ratings); de facto, the crisis has shifted that responsi- or protect private property? This has weakened confidence bility almost entirely back to governments. in the region's legal security, to the detriment of long-term investment. There is no disagreement, however, over the Equity More than Equality , need to give all Latin Americans the same opportunities, as a matter of social justice or as a call to personal effort. Equity We have learned the value of knowing the poor by name. enjoys support across the political spectrum. The problem An estimated 8 million Latino-Americans fell into poverty was that we had never been able to systematically measure in 2009, and about 5 million missed their chance to leave inequality of opportunity, in Latin America or anywhere poverty behind. Those are sad numbers; but, compared with else. The development profession simply lacked the method- past experience, they are very small. What sheltered us? We ological tools to monitor equity, making it all but impossible avoided jumps in inflation, so people's purchasing power did to design, implement, and evaluate public policies that target not melt. But more remarkably, for the first time we had ef- human opportunity. fective mechanisms to protect the poor. Thirteen of our That changed in 2008. A new technology to measure in- countries had spent the previous decade identifying the poor equality of opportunity--the Human Opportunity Index one by one, and setting up channels to transfer cash directly (HOI)--became available, the creation of a team of Latin to them--not an easy task when you think that the poor American researchers. In essence, the HOI calculates how rarely have bank accounts or even postal addresses.3 This has personal circumstances (like gender, skill-color, or family in- provided a platform for the next big move in Latin Ameri- come) affect the probability a child has of accessing the serv- can social policy: to focus on equality of opportunity, on giv- ices that are necessary to succeed in life (like timely ing everybody the same chances rather than the same education, basic health care, or connection to electricity). rewards, on equity rather than equality. Figure 3 shows the 2010 HOI for Latin America. Latin America remains the most unequal region on earth. The HOI, combined with the data and logistics embed- Inequality dominates virtually all its development out- ded in the direct cash transfer programs that Latin America comes--income, educational achievement, landownership. now has, will make it possible to redirect its social policy to- Taxation and public expenditures have made little difference ward equity (where there is consensus) and away from equal- in addressing the problem (figure 2). ity (where there is not). How? Many existing social policies The result has been acrimonious political disagreement and programs are already equity enhancing. But focus on over the proper role of the state: should it redistribute wealth equity reveals new points of emphasis along the individual's 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 3. Human Opportunity Index, 2010 That will need to change soon. Technology and politics 100 will help. New ways to hold public institutions accountable 90 have been penetrating the region for a while, initially among 80 municipalities and provinces where mayors and governors 70 face voters more closely. We now have standards to measure 60 the quality of education, infrastructure, security, and any HOI 50 other public service. How many words per minute should a 40 second-grader read? At least 60. How much should the cost 30 of logistics be for every dollar exported? No more than 10 20 cents. What should be the "normal" annual homicide rate? 10 Three for every 100,000 people. The list goes on. Few serv- 0 ices in few of our countries are, of course, up to par. But po- litical leaders who have committed publicly to this kind of Re Bra n pu zil a, n e Co . B ina ru a M uay Co uad o lo or Do ca/ am bia rib ca a e Bo blic Pa Pe ia ra ru El an ay Gu alv ma H tem or N du la ar as ua an bea el rge hil st . d U Ric Ec exic liv on a a ad P gu ic r Ca ai ag R t m S a zu A C g results do very well in the polls (for example, in Brazil). Oth- i J ers will surely follow. The average Latin American state will ic er in ne Am m be increasingly managed and judged by the results it achieves. Ve tin There will be another force pushing the state toward results- La country/region based management--devolution. Ushered in by the return Source: World Bank 2010 Human Opportunity Report. of democracy in the 1980s, Latin America entered a rapid process of decentralization in the mid-1990s. Tax and ex- penditure responsibilities were delegated to provinces and life cycle. Early interventions, from pregnancy monitoring municipalities. The quality of public services did not always and institutional births to toddlers' nutrition and neurolog- improve. But decentralization proved popular and is bound ical development, get a new sense of priority. So do pre- to deepen. At the same time, the new ways to do social as- school access (such as prekindergarten social interaction) sistance described earlier showed the possibilities opened by and primary-school achievement (such as reading standards the state's ability to communicate with, and transfer re- and critical thinking). The physical security, reproductive ed- sources to, individual citizens. On a simple magnetic card or ucation, mentoring, and talent screening in adolescents--all even a cell phone, the state can transfer directly to the ben- areas that are often overlooked--gain new relevance. A bat- eficiary the funds to buy or the right to access almost any tery of legal and institutional preconditions becomes essen- service, from vaccination to college education. There is no tial: from birth certificates, voter registration, and property longer a need for intermediaries. Decentralization will be titles; to the enforcement of antidiscrimination, antitrust, gradually moving down to the citizen's level; in a way, it will and access-to-information laws. And blanket subsidies that, become "devolution." This new, direct relationship between at the margin, are consumed by those who do not need them (free public college education for the rich, to name one) turn into opportunity-wasting aberrations. If nothing else, the quest for equity will lead to a final push in the decade-long Figure 4. Trust in the State process of subsidy focalization, and will spell the end for a way of giving out public assistance that was blind to the 70 army needs of the recipient (a way that was intrinsically unfair). 60 police courts approval rate (%) 50 party Trust the State parliament 40 From now on, we will demand a lot more of the state--to 30 spend more, to regulate more, to protect more. Trust in free markets has been damaged. But Latino-Americans never 20 really trusted the state either. That is why they refuse to fund 10 it, and remain trapped in a vicious circle of tax evasion and deficient public services. Even progress in fighting corrup- 0 East Asia European New Europe Latin America tion (which, unheralded, has occurred) has not done much Union to rebuild the relationship between our state and our people region (figure 4). Source: Blind 2006. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise people and the state is generating, and will continue to gen- responsive public sector, may not yet be universal values in erate, a wealth of information--about costs, quality, target- the region; but an increasing number of countries are adopt- ing, needs, outcomes, impacts. Monitoring and evaluation of ing them as part of their development strategies. Our voters policies and programs will be much easier. And management begin to reward sensible policy making. At the same time, by results will become natural. the rapid growth of the middle classes in Asia should ensure high, long-term prices for what Latin America sells. If well A Global Player managed, this "commodity platform" could be the stepping- stone for the region to upgrade its productive capacity (es- The 2009 crisis created new forms of external support and pecially its human capital) and expand its brand beyond integration for Latin America. Our multilateral lenders were natural resources. promised larger lending capacity and more fair representa- Are there downside risks? Yes, many. Most come from the tion. Flexible financing for good performers was quickly of- global economy. The recovery could be a slow, protracted fered. The G-20 brought Argentina, Brazil, and Mexico to process, dragged down by balance-sheet adjustments (for ex- the table where the decisions that will shape the world will ample, in mortgage markets) or second-round effects (such be made. In the redesign of financial regulation, the next as persistent unemployment). Commodity prices may dive round of trade negotiation, or the efforts to slow climate if the liquidity injected by the G-7 during the crisis is rolled change, Latin Americans now have a better opportunity to back too quickly, or if China's domestic consumption does be heard. They will also count in the rebalancing of the not compensate for the return of its public investment to global matrix of saving and consumption; after all, their con- prestimulus levels. Massive fiscal imbalances in the United sumption is larger than China's in absolute dollar terms and States will not be easy to correct, hinting at much higher in- as a proportion of GDP. The region is even seeing the emer- terest rates (and/or dollar inflation) in the near future. A gence of its first, own global leader--Brazil. downgrade of sovereign debt among developed countries But our contribution to global commons will go farther. could trigger a flight to safety and away from emerging mar- A new generation of former national leaders left, or will soon kets. And there are plenty of uncertainties at home: specific leave, office in success and popularity (in Brazil, Chile, Colom- countries could still run into overheating and high inflation, bia, Costa Rica, Mexico, and Uruguay, to name a few). Play- breakdowns in internal security, or political turbulence. ing by market rules but listening to their people's needs, they Any of those risks could derail Latin America's growth, delivered prosperity and social progress for their countries. at least for a while. But for the first time in decades, its fun- Their governments have not only done well using traditional damentals look solid and the horizon promising. In the base policy tools, but have also pioneered new ones (such as struc- external scenario, and with variations across countries, the tural fiscal balances and conditional cash transfers). They are region as a whole is converging on a path of sustained de- now credible spokespeople for good administration, and are velopment. much sought after in the international conference circuit. They have become global assets who will give the region a Notes new voice. This new relevance will bring new disciplines, and will re- 1. The views presented in this report are the author's inforce others. It will be more difficult for Latin American own, and do not necessarily represent those of the World countries to backtrack in trade and financial openness, and Bank Group or of its board of executive directors. more painful to lose investment grades. Worldwide rankings 2. At the margin, the crisis also showed the wisdom of will have larger domestic impact (call it the "embarrassment building agile public investment systems. Several countries factor"), from those dealing with public transparency to (Brazil, Chile, Colombia, Peru) quickly embarked on strength- those dealing with the quality of the business environment. ening those systems. And light may begin to shine on long-postponed reforms, 3.The process of identifying the poor forced a parallel without which the benefits of integration are diluted--no- process of integration of individual social records across min- tably, in education and infrastructure. istries and agencies; this should further facilitate tailoring so- cial programs to individual needs. Conclusion: If the World Holds, Latin America Will Take Off About the Author The alignment of domestic and external factors augurs well Marcelo M. Giugale is the World Bank's director of economic for Latin America's future. 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The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. It is produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at www.worldbank.org/economicpremise.