By Andrés Velasco, Former Finance Minister of Chile
SANTIAGO – The Inter-American Development Bank declared last July that this would be “Latin America’s Decade.” A couple of months later, The Economist endorsed that idea, which has since been repeated by countless apologists and experts.
There is nothing like a little economic growth to get pundits’ juices flowing. And Latin America is growing, by 6% last year and an estimated 4.75% in 2011, according to the International Monetary Fund.
Compared with the region’s mostly sluggish performance over the last three decades, this looks like takeoff velocity. And, compared to the dismal recent record in North America and Europe, it looks positively supersonic.
Latin America’s stock markets are up sharply since the crisis, as are property prices in those few countries that keep track of house values. No wonder so many are so excited.
The mood about Latin America was equally optimistic at the start of the 1980’s. Bank loans from the U.S. were plentiful, and countries like Argentina, Chile, and Uruguay were growing fast.
But then Paul Volcker increased interest rates in the U.S., the dollars went home, most countries defaulted on their debts, and the 1980’s became a “lost decade” for Latin America.
The early and mid-1990’s witnessed another wave of optimism. Commodity prices were high, external financing plentiful, and many Latin American countries grew. Having adopted the liberalizing reforms dictated by the Washington Consensus, Latin America was thought to have turned the corner. But then came Mexico’s Tequila Crisis in 1994, followed by the Asian meltdown, which hit Latin American economies hard. Brazil blew up in 1998, and Argentina melted down in 2001.
I do not mean to suggest that Latin America is on the verge of another debt crisis – far from it. In many countries – including Brazil, Peru, and Colombia – macroeconomic management is far better than it was in the 1980’s or early 1990’s.
But today’s situation shares two features with the earlier episodes of financial euphoria over Latin America: sky-high commodity prices and cheap international money. In fact, for many of the region’s countries, the terms of trade are higher and the relevant global interest rates lower than they have ever been. These factors, more than any virtuous policy change in recent years, are propelling growth.
Indeed, today there are two Latin Americas: natural resource-rich South America and natural resource-poor Central America and Mexico. Not surprisingly, South America is growing much faster than its neighbors to the North – 4.4 versus 2.7% in 2010-11, according to a recent Inter-American Development Bank report. The report estimates that Argentina’s economy will expand by 6.1% in that period, while Costa Rica’s will grow by 3.8% and El Salvador’s by just 1.6%. Is there a single economist who believes that Argentina’s policies are almost four times better than El Salvador’s?
Plentiful international capital is also making a difference. The financial markets’ recent darling is Brazil, which grew at a breakneck 7.5% pace in 2010, fueled by almost $100 billion in capital inflows. By the end of 2016, Brazil will have hosted both the World Cup and the Olympic Games.
Few doubt Brazil’s primacy when it comes to soccer. But its economic competitiveness is another story. In this cup, Brazil does not even make it to the playoff round of 32, occupying 58th place in the competitiveness ranking of 139 countries compiled by the World Economic Forum. Ahead of Brazil one finds Montenegro, Mauritius, and Azerbaijan.
In the past, episodes of dirt-cheap money and commodity prices on steroids ended badly for Latin America. Will this time be different?
Pardon the economist’s stock answer: it all depends. First of all, it depends on whether countries can prevent financial bubbles from developing.
The IMF recently asked in a report: “Are bubbly conditions taking hold?” After pointing to soaring credit growth in most South American countries (in Brazil, growth in mortgage lending exceeded 40% during 2010, more than tripling the stock of credit outstanding in 2007), the Fund concluded that “the current expansion does not yet rise to the level of a credit boom,” though “it would if the expansion were sustained for a prolonged period.”
Notice the “not yet.” When a doctor says that a patient is “not yet” dead, family members should start to worry.
In the same report, the IMF rang alarm bells over potential equity bubbles, pointing out that “stock prices are currently above trend levels in most countries, with signs of stretched valuations in a few countries (Chile, Colombia, and Peru).” In Chile, the report met with irate denials from the brokers and fund managers who make their living selling Chilean stocks to investors.
Whether the current episode will end in tears also depends on fiscal policy. Once upon a time in Latin America, fiscal policies were extremely pro-cyclical: whenever commodity prices fell, governments lost access to capital markets, so they had to eliminate their deficits just when conditions called for fiscal expansion.
This has slowly begun to change. With public debt much lower than in the past, several Latin American countries ran counter-cyclical deficits for the first time in 2009, thereby cushioning the domestic impact of the external blow from the global financial crisis.
The problem is that governments in the region have yet to realize that countercyclical fiscal policy implies rowing against the current in both parts of the cycle: spending more when times are bad (the easy part) and spending less when times are good (the true test of virtue). Today, fiscal policy remains too expansionary in virtually every Latin American country.
That fiscal impulse, coupled with high commodity prices and abundant credit, continues to fuel economic growth today – often at the expense of stability and growth tomorrow. Latin America’s time has finally come, too many pundits will keep saying. If only they were right.