How durable do you think the impact of the financial crisis will be on Latin America?
This is a major economic event that is going to trigger a relatively sharp deceleration of global growth which will probably last the best part of the next two years. In that process I would expect commodity prices (copper, oil, other minerals, and soy beans) to come down as global growth reduces its momentum. Also access to foreign funds is going to be more limited and more expensive. Latin America is going to be hurt by the reduction in the price of its exports and a reduction in its access to finance. Those are going to be the main transmission mechanisms to the domestic economy. There is also going to be a reduction –even a decline –in remittances that people from those countries send home
Which have already been declining…
…well, they were rising very, very rapidly for a long time; then they have stagnated and are now declining in Mexico and we don’t know much about what is happening in Central America. There are other countries in Latin America that will be impacted by lower U.S. growth. The car industry in the U.S. is going to be significantly hit because of the recession and the problems with financing cars. That is going to affect countries with major activities in the car and spare parts industry such as Mexico. Central America will be impacted by the decline in the garment sector; they are already struggling with competition from China…So it’s going to be a difficult couple of years for everyone in the region, but not all countries are equally well prepared to cope with this difficult international environment.
How do you think Latin America’s reaction will compare to say that of Asia, which one will be better prepared to handle these hurdles?
It’s a big open question. In Asia China has been growing at 10 or 11 per cent over the last years, and it is expected to slow down to like only 8%. So for some countries in Asia, the Chinese market will continue to be a source of dynamism. Some countries in the Pacific rim of Latin America whose trade is more focused on Asia than on the American continent may not suffer as much because there will be more dynamism in Asia than in the U.S. So the baseline scenario for me is that Asia will do better, but that depends on things not getting too complicated in China, and there is somewhat of a possibility that China will get into trouble. That would be a very different world scenario because China is big.
And for a long time they have been putting a good number of restrictions and regulations on their financial sector, so…
Yes, but Chinese growth has been much centered on export growth, and investment for that export growth, so if trade slows down, exports will slow down; as exports slow down, investment for additional exports will slow down. So you have important factors that are pressing the Chinese economy. China has a big surplus in its external account, so it could afford going in a spending spree and the world would therefore benefit. But engineering a spending spree is not that easy and to what extent they are willing to do it without creating additional disturbances elsewhere is an open question. So there are forces from this international environment that tend to slow down China, and how China manages them is crucial for the rest of the world.
Coming back to Latin America, its development has always been based on the use of natural resources, so a drop in commodity prices, as you mentioned, is affecting the region. Do you envisage structural changes in Latin America’s economy as a result of the fall in commodity prices?
Well, Latin America is relatively heterogeneous in terms of its intensity in natural resources. I would say that Mexico and Central America are not very intensive in natural resources; they are mostly intensive in manufacturing. Brazil had a significant non-natural resource sector, but the stuff that has been moving in Brazil has been very natural-resource intensive in the last years, so they had a mining boom…
… an oil boom..
A bio-fuels boom, a sugar cane boom, and an agricultural boom associated with soy beans, so export growth lately has had a great component of natural resources. But they also export airplanes and a very significant amount of manufacturing. So there is a more manufacturing-oriented trend in Latin America, just as there is a service-oriented trend. Service-oriented exports from Chile are a significant part of their overall export package, especially financial services, retail services, and other investments throughout the region. Latin America is changing. This decade has been the fastest decade of world growth on record. In that period of growth, the engine of growth was U.S. spending and China’s growth. When a country grows faster than the rest of the world, as China was doing, it tends to export faster than the rest of the world imports and it tends to import faster than the rest of the world imports. By doing that it tends to raise the price of what it imports (soy beans from Argentina, copper from Chile, oil from Venezuela) and it tends to lower the price of its exports (garments, toys, electronics) and that means adding competition to Mexico and Central America in the U.S. market. As a result, international forces have been in favor of Latin America going back to natural resource-intensive activities because that was what China was buying. In a world of slower growth, the pressures to keep moving in that direction are going to slow down, and consequently that may give rise to larger relative importance of less resource-intensive activities as the dynamic part of the economy.
What would you recommend to central bankers throughout Latin America?
I think there is a lot of wise central bankers and finance minister throughout Latin America. There is a group of them who have managed their economies recklessly and are now in a very perilous situation. There are people out there who think that this is the final crisis of capitalism and those who have not followed market economies have proven right. I think this is totally wrong. What will happen is that precisely the group of anti-market economy governments such as Venezuela, Argentina, and Ecuador, are going to be most probably impacted by this crisis. They are highly reliant in very few exports (oil in Venezuela, soy beans in Argentina, oil in Ecuador). The price of oil has declined more than 40% since July. They have been running their economies by being extremely reliant on taxation of their export sector with very little investment on those export activities. They have been pegging their currencies to the U.S. dollar. So while they pretend to be more independent, they actually have a more dependent monetary policy. Because of that the Real in Brazil has depreciated around 40%, the Chilean peso has depreciated almost 40% in Chile, but the Argentineans have more or less pegged their exchange rate vis-à-vis the dollar, so they find themselves with a free trade agreement with Brazil but with a currency that is 40% stronger than it was before. That looks like the kind of perfect storm that occurred in 1999 when Brazil depreciated its currency by 40%. They have a weakened fiscal position, an unsustainable exchange rate position, no access to international finance because they have scared away investors at a time when they would have wanted to borrow more given the decline in the price of their exports. So they are setting themselves up to a very difficult transition. Instead, countries like Chile were putting money aside when they had huge surpluses because the price of copper was running high, which now gives them more flexibility to adjust downward by increasing domestic spending and compensating by the loss of export earnings. So countries have learned many lessons from the crises of 1982, 1983, from the Tequila crises of 1994-95, from the Russian crisis of 1998, or the Argentina crisis of 2001. So there are many experiences that are now expressed in a very prudent stance in countries like Colombia, Peru, Mexico, Chile, even like Brazil, but very different policy stances in countries like Ecuador, Venezuela, and Argentina.