The International Crisis and Latin America: Growth Effects and Development Strategies. Vittorio Corbo Klaus Schmidt-Hebbel

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1 ::: The International Crisis and Latin America: Growth Effects and Development Strategies Vittorio Corbo Klaus Schmidt-Hebbel World Bank Seminar on Managing Openness: Outward-oriented Growth Strategies after the Crisis May 10, 2010 Washington, DC :::

2 ::: Outline 1. Introduction 2. Data 3. Dating Recessions 4. Growth Model and Empirical Strategy 5. Estimation Results 6. Decomposing the Amplitude of the and Recessions 7. Implications for Policies and Growth Strategies 8. Final Remarks

3 ::: 1. Introduction

4 ::: Is Latin America different now? (1) LatAm was hit by both the Asian Crisis and the Global Crisis Yet significant structural and policy changes were implemented by many countries in LAC during the past decade Hence were the effects of the international crises and recessions on LatAm different this time?

5 ::: Is Latin America different now (2)? We address this question in four steps: (1) identification and dating of both recessions (2) estimation of GDP growth performance based on short and long-term growth factors (3) decomposition of amplitude of both recessions and the role of individual growth determinants international factors, structural conditions, and policy responses (4) main implications of crises for Latin America and some strategies to grow out of the crisis

6 ::: 2. Data

7 ::: Data Country Sample Seven major LAC countries: Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela (91% of LAC s GDP in 2008) Time Sample Quarterly data, 1990:1-2009:4

8 ::: Average GDP Growth in LatAm Simple average of annualized quarterly GDP growth rates of seven major Latin American countries, based on official GDP series that are seasonally adjusted by national authorities.

9 ::: GDP growth in LatAm countries (1)

10 ::: GDP growth in LatAm countries (2)

11 ::: GDP growth in LatAm countries (3)

12 ::: Average Output Gap in LatAm Simple average of output gaps of seven major Latin American countries, based on official GDP series that are seasonally adjusted by national authorities and the Baxter-King filter.

13 ::: 3. Dating of Recessions

14 ::: Dating of recessions (1) Starting points: based on Calvo (2005) and Eichengreen and O Rourke (2009) Fixed effects panel regression of GDP growth on two dummy variables for two recessions Search conducted by extending end-points by several quarters

15 ::: Dating of recessions (2) Final dating based on largest and most significant dummy parameter estimates Results for average LatAm economy (paneldata!) different for individual economies Final dating of recessions for LatAm: Asian crisis: 1998q3 1999q2 Global crisis: 2008q4 2009q2 Growth lowered by 7.6 and 8.6 p.p. respectively

16 ::: Dating of recessions (3) Estimation Method: Fixed-effects (within) regression Dependent Variable: Growth of Real GDP Time Sample: 1990:1-2009:4 (quarterly frecuency) Countries: ARG - BRA - CHI -COL -MEX - PER - VEN Global Financial Crisis Period Asian Crisis Period 2008q3-2009q2 Estimated Parameters 2008q4-2009q2 Estimated Parameters 2008q4-2009q1 Estimated Parameters Asian Global Asian Global Asian Global 1998q3-1999q *** *** *** *** *** *** (-6.333) (-5.358) (-6.317) (-5.820) (-6.290) (-6.658) 1998q2-1999q *** *** *** *** *** *** (-5.731) (-5.380) (-5.714) (-5.840) (-5.684) (-6.674) 1998q1-1999q *** *** *** *** *** *** (-6.058) (-5.427) (-6.040) (-5.881) (-6.009) (-6.710) 1997q4-1999q *** *** *** *** *** *** (-5.470) (-5.419) (-5.451) (-5.874) (-5.417) (-6.704) 1997q3-1999q *** *** *** *** *** *** (-4.712) (-5.393) (-4.691) (-5.852) (-4.654) (-6.684) 1997q2-1999q *** *** *** *** *** *** (-3.471) (-5.325) (-3.448) (-5.792) (-3.409) (-6.632) 1998q3-1999q *** *** *** *** *** *** (-5.394) (-5.353) (-5.377) (-5.816) (-5.347) (-6.654) 1998q3-1999q *** *** *** *** *** *** (-4.356) (-5.331) (-4.337) (-5.797) (-4.305) (-6.637) 1998q3-2000q *** *** *** *** *** *** (-3.407) (-5.295) (-3.386) (-5.765) (-3.352) (-6.609) 1998q3-2000q *** *** *** *** *** *** (-4.045) (-5.354) (-4.023) (-5.817) (-3.986) (-6.654) 1998q3-2000q *** *** *** *** *** *** (-4.255) (-5.387) (-4.233) (-5.846) (-4.194) (-6.679) 1998q3-2000q *** *** *** *** *** *** (-4.330) (-5.406) (-4.307) (-5.863) (-4.266) (-6.693) Observations t-stats calculated using robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

17 ::: Average GDP growth in LatAm around crises Asian Crisis Global Financial Crisis

18 ::: 4. Growth Model and Empirical Strategy

19 ::: Specification and Data Data Unbalanced panel of quarterly data for seven countries Estimation Method Multivariate dynamic fixed-effects unbalanced paneldata regressions

20 ::: Literature (1) Long-term determinants of growth Barro (1991), King and Levine (1993), Easterly and Rebelo (1993), Easterly, Loayza, and Montiel (1997), Levine, Loayza, and Beck (2000), Dollar and Kraay (2002), Calderón, Fajnzylber and Loayza (2004), Barro and Sala-i-Martin (2004), and Calderón, Loayza and Schmidt-Hebbel (2006). Short-term determinants of growth Every short-term macroeconomic model including the DSGE models used in short-term macroeconomic analysis and projections.

21 ::: Literature (2) Medium-term determinants of growth IMF s WEO (chap. 4, 2009). Recession in Latin America Österholm and Zettelmeyer (2007), Caruana (2009), Jara, Moreno and Tovar (2009), IADB (2009a), IADB (2009b), IMF (2009a), IMF (2009b), Ocampo (2009), World Bank (2009) and Soto (2010).

22 ::: Behavior of growth in LatAm (1) Specification: Multivariate dynamic fixed-effects panel data regression that nests long and short-term growth determinants and potential interaction effects: where: y it y y : dependent variable X : long-term growth variables it 1 K : domestic policy variables M : structural variables Z : foreign cyclical variables with interactions between M and Z, Z it ' X Z it ' M and allowing for structural breaks in coefficients after 2000 X it Z it K it ' ' MZ K i M it ' it M

23 ::: Behavior of growth in LatAm (2) (1) Long-term growth variables Private Credit, Secondary School Enrollment, Inflation Rate, Fiscal Balance, and Political Certainty (2) Structural variables Financial and Trade Openness, Net External Assets, International Foreign Reserves, and Exchange Rate Regime (3) Foreign cyclical variables Channels of transmission: Terms of Trade Growth, Growth of Trading Partners and of World Exports, Capital Inflows to LatAm, and Sovereign Spreads (4) Domestic policy variables Government Consumption and ex-ante Real Interest Rate (5) Interactions of structural and foreign cyclical variables 23

24 ::: 5. Estimation Results

25 ::: Growth regression results (1) Estimation Method: Fixed-effects (within) regression Dependent Variable: Growth of Real GDP Time Sample: 1990:1-2009:4 (quarterly frecuency) Countries: ARG - BRA - CHI -COL -MEX - PER - VEN Unbalanced Unbalanced Panel Panel (1) (2) Unbalanced Panel w/ Structural Changes (3) GDP Growth (lagged) (0.063) (0.056) (0.045) Long-Term Variables Private Credit 0.080** 0.068* 0.101** (0.035) (0.036) (0.040) Secondary School Enrollment 0.227* * (0.132) (0.133) (0.167) Inflation ** ** *** 0.210* (0.078) (0.074) (0.098) (0.115) Fiscal Balance 0.610*** 0.753*** 0.802*** (0.208) (0.213) (0.240) Political Certainty 0.249** 0.292*** 0.377*** ** (0.101) (0.100) (0.102) (0.023) Structural Variables Financial Openness 0.044*** 0.041*** 0.087*** ** (0.016) (0.015) (0.018) (0.009) Trade Openness 0.322*** 0.319*** 0.318*** 0.190*** (0.078) (0.077) (0.102) (0.056) Net External Assets 0.081** 0.096*** (0.036) (0.036) (0.041) International Reserves 0.279*** 0.248*** 0.829*** *** (0.071) (0.078) (0.202) (0.194) Exchange Rate Regime *** (0.009) (0.009) (0.011) (0.009) 25

26 ::: Growth regression results (2) Foreign Cyclical Variables Terms of Trade Growth (0.009) (0.009) (0.010) Growth of Trading Partners 0.221* (0.133) (0.138) (0.137) Growth of World Exports 0.081*** 0.082*** 0.081*** (0.022) (0.022) (0.021) Capital Inflows to Latin America 0.573** 0.475** 0.419* (0.244) (0.239) (0.252) Sovereign Spreads (0.057) (0.058) (0.059) (0.020) Domestic Policy Variables Government Consumption 1.386*** 1.362*** 1.516*** (0.328) (0.319) (0.304) Real Interest Rate ** *** *** 0.289** (0.071) (0.068) (0.077) (0.119) Interactions Growth of Trading Partners * Trade Openness 1.170* (0.657) (0.607) Growth of Trading Partners * Financial Openness * (0.332) (0.301) Capital Inflows to Latin America * Financial Openness ** (0.603) (0.609) Sovereign Spreads * Net External Assets 0.284** 0.377*** (0.125) (0.130) Constant ** ** *** (0.122) (0.118) (0.139) Observations R-squared *** p<0.01, ** p<0.05, * p<0.1 Robust standard errors in parentheses 26

27 ::: Significant growth factors Long-term growth determinants: financial depth, school enrollment, inflation (less since 2001), fiscal balance, political certainty (less since 2001) Structural variables: financial openness (less since 2001), trade openness (more since 2001), international reserves (less since 2001), exchange rate regime (only since 2001) Foreign cyclical variables: foreign trading partners growth, world export growth, capital inflows. Note: terms of trade and sovereign spreads not significant! Domestic policy variables: government consumption, real interest rate Four significant interaction effects Significant structural breaks in 2001 for 7 variables

28 ::: 6. Decomposing the Amplitude of the and Recessions

29 ::: Dissecting LatAm s recessions Compare LatAm s growth performance in both recessions Decompose amplitude of the recession in both events the average cumulative GDP decline in 7 individual countries between last quarter before the recession and last quarter of the recession Decomposition allows to identify the most relevant recession determinants in both crises Within-crisis decomposition: y it X it ' ˆ X K it ' ˆ K M it ' ˆ M Z it ' ˆ Z ( M it Z it )' ˆ MZ

30 ::: Recessions in LatAm Amplitude of GDP Growth Decline Asian Global Financial Crisis Crisis 1998q3-1999q2 2008q4-2009q2 Argentina -5,20% -1,55% Brazil -1,03% -3,99% Chile -3,88% -4,40% Colombia -6,82% -0,87% Mexico 3,37% -11,09% Peru 1,15% -3,64% Venezuela -8,51% -3,59% Simple Average -2,99% -4,16% Weighted Average -1,15% -5,24% Cumulative GDP growth rates during recessions

31 ::: Decomposing LatAm s recessions (1) Asian Global Financial Crisis Crisis 1998q3-1999q2 2008q4-2009q2 Amplitude of GDP Growth Decline -2.99% -4.16% Structural Changes NO Changes YES Sources: Long-Term Variables -1.68% 0.77% 0.05% Private Credit 0.24% 0.44% 0.44% Inflation 0.65% 0.97% -0.73% 0.24% Secondary School Enrollment -0.14% 0.15% 0.15% Fiscal Balance -1.17% -0.73% -0.73% Political Certainty -1.26% -0.06% 0.01% -0.05% Structural Variables -0.57% 0.59% -1.70% Financial Openness 0.73% -0.60% 0.14% -0.46% Trade Openness -0.53% -1.32% -0.79% -2.11% Net External Assets -0.08% 0.08% 0.08% International Reserves -0.68% 2.43% -1.64% 0.79% Exchange Rate Regime -0.01% 0.00% 0.00% 0.00%

32 ::: Decomposing LatAm s recessions (2) Foreign Cyclical Variables 0.54% -2.60% -2.74% Terms of Trade Growth 0.02% -0.32% -0.32% Growth of Trading Partners 0.26% -1.36% -1.36% Growth of World Exports 0.53% -0.05% -0.05% Capital Inflows to Latin America -0.05% -0.68% -0.68% Sovereign Spreads -0.22% -0.19% -0.14% -0.33% Domestic Policy Variables -0.99% -0.14% 0.99% Government Consumption 0.69% 1.12% 1.12% Real Interest Rate -1.68% -1.26% 1.13% -0.13% Interactions -0.02% -0.67% -0.67% Growth of Trading Partners * Trade Openness 0.00% -0.19% -0.19% Growth of Trading Partners * Financial Openness 0.10% -0.35% -0.35% Capital Inflows to Latin America * Financial Openness -0.09% -0.10% -0.10% Sovereign Spreads * Net External Assets -0.02% -0.03% -0.03% Structural Changes post % Explained Variation -2.72% -4.07% -4.07% Unexplained Variation -0.26% -0.09% -0.09% Total Variation -2.99% -4.16% -4.16%

33 ::: Decomposing LatAm s recessions (3) 6% 5% Asian Crisis (amplitude: 3.0%) Global Financial Crisis (amplitude: 4.2%) 4% 3% 2% 1% 0% -1% -2% Long-term Structural Foreign Cyclical Domestic Policy Interactions Unexplained

34 ::: Explaining LatAm s recessions (1) (Unweighted) average amplitude of both recessions was larger this time a cumulative -3.0% vs. -4.2% Our explained variation is -2.7% for and -4.1% for recession: largely due to domestic factors, NOT to foreign cyclical variables: Lower inflation and rising financial openness dampened the recession Higher political uncertainty and rising country risk spreads deepened the recession Positive growth of world GDP and exports dampened the recession Fiscal policy (higher fiscal balance and government consumption) deepened the recession Higher interest rates and lower international reserves, in defense of non-flexible exchange-rate regimes, contributed strongly to the recession

35 ::: Explaining LatAm s recessions (2) recession: in contrast to , largely due to the world recession, i.e., foreign cyclical variables All five foreign cyclical variables contributed to the recession, jointly they explain 2.7% of 4.1% Collapsing growth of LatAm s trading partners made the largest contribution Declining trade through lower trade openness and negative world trade growth deepened significantly the recession Lower inflation and rising international reserves dampened the recession Fiscal policy (lower fiscal balance + higher government consumption) was largely neutral for growth Monetary policy: 2009 nominal interest rate reductions were more than offset by inflation decline; hence real interest rates increased. But their effect on growth is close to nil after 2001.

36 ::: 7. Implications for Policies and Growth Strategies

37 ::: Policies and Growth Strategies (1) Most LatAm countries carried out important policy and institutional reforms aimed at strengthening their macro fundamentals. improving their fiscal accounts, putting in place inflation targeting monetary frameworks -to reduce inflation towards single digit annual levels- and introducing more flexible exchange rate regimes public debt to GDP ratios have improved as well as the stock of gross external debt to GDP ratio when the global financial crisis struck, the size of their macroeconomic imbalances were manageable therefore, domestic policy did not amplify the recession this time

38 ::: Policies and Growth Strategies (2) In spite of the progress that has been achieved, Latin America has still a pending agenda: 1. to raise in a sustainable way its rate of growth 2. to make further progress in reducing poverty 3. improving its income distribution Limited state capacity public policies are unpredictable, slow to be implemented and costly for businesses the merit system is not common in the public sector public services are of low quality investor protection leaves much room to be improved enforcement of contracts is expensive and slow

39 ::: Policies and Growth Strategies (3) Raising Total Factor Productivity LatAm still has in place important entry and exit barriers to business, limiting the process of creative destruction rigid labor laws (including high minimum wages) distort wages limitations to adjust working hours and high firing costs These restrictions complicate participation of low-skilled workers in formal labor markets, especially low-skilled youth and mothers LatAm still ranks very low in internationaleducation achievement tests. Policy reforms focused at reaising labor rpoductivity and productive efficiency are key for raising aggregate income and income of the poor and unskilled in particular, contributing to lower poverty and improved income distribution.

40 ::: 8. Final Remarks

41 ::: Is LatAm different now? (1) On average, yes LatAm has improved its macro policy framework: Strengthening macro regimes by shifting from less discretion to more rules Exchange-rate regime: adopting (largely dirty) floating ER regimes (effective dampener of foreign shocks) Strengthening monetary policy regime by adopting fuller-fledged versions of flexible IT LatAm has also improved structural conditions: strengthened global links through trade and financial openness strengthened external positions, especially foreign reserve positions (consistent with dirty floats)

42 ::: Is LatAm different now? (2) More openness has contributed to higher growth but partly exposed the region to the effects of adverse foreign shocks However: LatAm is still very heterogeneous, exhibiting large (and possibly increasing) heterogeneity in regimes and policies, as well as in performance records LatAm still faces a long agenda of economic and institutional reforms to spur growth, raise its resilience to foreign shocks, and defeat proverty.

43 ::: Is LatAm different now? (3) (1) Continue improving macro-financial policy framework Adopt full-fledged IT (or PLT), clean up dirty ER floats, adopt fiscal rules and policy regimes (independent fiscal councils) Adopt the world s (still evolving) best practice in macroprudential regulation (2) Deepen globalization Strengthen unilateral trade and financial integration into world markets Maintain plain level field: resist Tobin taxes on portfolio flows, subsidies to FDI, trade protection, picking sector winners (3) Deepen and widen structural reforms: micro incentives, education, labor markets, government reform in support of higher long-term growth

44 ::: 9. Appendix

45 ::: Long-term growth determinants Note: Simple averages for seven major Latin American economies.

46 ::: Structural growth determinants Note: Simple averages of seven major Latin American economies.

47 ::: Foreign cyclical variables Note: Simple averages of seven major Latin American economies.

48 ::: Domestic policy variables Note: Simple averages of seven major Latin American economies.

49 ::: The International Crisis and Latin America: Growth Effects and Development Strategies Vittorio Corbo Klaus Schmidt-Hebbel World Bank Seminar on Managing Openness: Outward-oriented Growth Strategies after the Crisis May 10, 2010 Washington, DC :::

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