Speech

Latin America: Structural Reforms and Competitiveness, Remarks by Rodrigo de Rato, Managing Director of the International Monetary Fund

March 24, 2006

As Prepared for Delivery

1. [Introduction.] Good morning. It is an honor to participate in this important conference. I welcome the occasion to discuss how the IMF sees the opportunities and challenges facing Latin America today. It is fitting that I am making these remarks in Mexico, a country that has transformed itself politically and economically over the past decade into a vibrant multiparty democracy and a model of sound macroeconomic management. Indeed, such transformations are occurring in emerging economies around the globe. A central theme of my vision for the Fund's medium-term strategy is to support these countries in new and different ways—with less need for standard program relationships and more work on understanding financial market risks and on mechanisms to insure against crises. In this new era for emerging markets, the stakes are high and the rewards great for those countries that can adapt and change to compete effectively in the global economy.

2. Mexico has been a leader in Latin America in addressing the macroeconomic and financial instability that stood in the way of growth and prosperity for so long. Stronger macroeconomic management has helped to contain and reduce fiscal deficits and debt here and, increasingly, across the region. Although debt ratios are still too high, many governments are working to reduce them and have taken advantage of easier financing conditions to reduce reliance on foreign currency debt and lengthen maturities. More independent monetary policy, within a framework of greater exchange rate flexibility in many countries, has been focused more clearly on reducing inflation. Unlike in earlier boom periods, external current account balances have also improved, strengthening national balance sheets.

3. These reforms have already yielded important dividends. Helped by a generally favorable external environment, growth in the region, after reaching a 24-year high in 2004, remained above historical averages at 4 percent in 2005 and we expect a similar performance again this year. Inflation in most countries is well contained, in sharp contrast to periods in the past. Here in Mexico, it is impressive to see the widely shared commitment to low inflation and macroeconomic stability. A steady and predictable economic environment is now recognized in your country as a national asset. Preserving it will build further resilience to damaging episodes of crisis—responsible in the past for throwing so many out of work and into poverty. It will also provide an environment in which investment and private enterprise flourish, and allow government to play its part in providing targeted social programs that help reduce poverty and inequity and create opportunity for all.

4. Despite the important gains so far, it is widely recognized in the region that Latin America can do more to realize its potential in today's globalized economy. While growth is now higher than in the past, it still lags disappointingly behind that in the rest of the world. Instead of converging with the industrialized countries, Latin America has barely kept pace in the past decade. And experience in other emerging regions of the world, including the transition economies of Europe as well as the dynamic Asian economies, shows that it is possible to achieve much faster growth than has been experienced in most of Latin America.

5. Higher economic growth would reduce poverty and help governments meet the region's pressing social needs. Progress in poverty reduction in much of Latin America has been modest and inequality remains high, with resulting pressures on societies. A clear lesson from other countries' experience is that sustained growth on a consistent basis is needed to reduce poverty. However, it is not enough on its own. Successfully targeted social programs, fair and broadly based fiscal regimes, labor markets that promote job creation, and high quality education opportunities for the neediest, are also key.

6. Latin America is in many ways well positioned to undertake the structural reforms needed to enhance economic performance. The region is benefiting importantly from a favorable external environment, with higher commodity prices, strong global growth and significantly lower financial costs. Capital is now flowing in from abroad, allowing governments to reduce vulnerability by rebuilding reserves and paying down foreign debt. The challenge is to resist the temptation to manage the exchange rate out of concern that upward flexibility will hurt competitiveness and growth. Lasting gains in competitiveness can best be secured through deepening structural reforms that would promote more efficient domestic markets and foster an attractive and competitive business environment. We have seen time and again, from Europe to Asia, the impressive gains that can come from such reforms. Chile, which stands out in the region on most measures of structural reform, as well as for its fiscal discipline and sound monetary policies, has enjoyed much stronger growth than in the rest of the region. In my talk today, I would like to discuss key elements of a structural reform agenda for the region and how best to secure a broad consensus for it.

7. I don't want to imply there is a simple recipe for success. But we see some common priorities for Latin American countries in policy areas that together are critical for fostering competitiveness. Reforms in these five areas can reinforce each other to spur productivity and growth and promote success in a globalized world:

• fiscal reform, to broaden and make more equitable the revenue base, bring down debt and empower governments to meet infrastructure and social needs;
• financial sector reforms, to promote domestic savings and foster the efficient use of these savings;
• labor market reforms to enhance flexibility and favor development of human capital;
• further opening to the competitive forces that drive innovation and change;
• a fair and transparent business environment that encourages investment and job creation.

8. Strengthened fiscal regimes will help entrench sound public finances for the medium term while also meeting the need for improved infrastructure. Reforms to broaden the tax base can promote a lasting reduction in the debt ratios that remain high across most of the region. Broader and more equitable tax systems also provide a more sustainable and efficient source of revenue for government spending needed for effective social programs and essential infrastructure. Setting fiscal policy in a medium-term framework has been successful in providing confidence in continued sound budget policy, such as in Chile. Here in Mexico, there is healthy debate about moving ahead with developing the tax base and reducing dependence on oil revenues, as well as embedding fiscal policy in a medium-term framework. Important steps forward have been taken, with the approval just this month of a medium-term fiscal reform law.

9. A strong and well-functioning financial system is a critical element in promoting investment needed for growth. As you in this distinguished audience know very well, Mexico has been a leader in strengthening its banking and financial system over the past decade. An impressive array of financial reforms have reinforced the supervisory and regulatory regime, opened the banking sector to competition and, more recently, promoted important advances in developing local capital markets. We have seen in other countries, including my own, how vital a strong financial system is for stimulating the efficient use of savings, both domestic and foreign, and thereby supporting higher productivity and faster growth.

10. A skilled labor force and flexible labor markets also are important for countries to take better advantage of globalization. In a more competitive and integrated world, jobs need to move flexibly from less productive to more productive sectors to take advantage of new market opportunities. Reforms to reduce labor market rigidity—a feature of many Latin American labor markets—can have very positive effects on job creation and growth. There are a number of examples of countries in both industrialized and emerging market countries that saw rapid increases in employment after introducing historic labor market reforms. A principal reason for labor market rigidity in Latin America has been to secure job security. But experience has shown that such labor market restrictions have had the opposite effect of retarding employment in the formal sector and encouraging the growth of informal labor markets that undermine the public finances in addition to reducing overall productivity. Instead, the best way to promote employment is to support the development of a dynamic and growing economy, with well-targeted and effective social programs to help those potentially hurt by change.

11. Another key lesson is the importance of trade liberalization and openness for productivity and growth. Greater trade openness can bring positive benefits in terms of economies of scale, more energetic competition, and the transfer of technology and even institutions. In comparison with other fast-growing regions, Latin America is still relatively closed to international trade, and tariff barriers remain high. Time and again, we have seen how dismantling barriers to competition and trade can foster growth and higher living standards. Growth in the dynamic economies of China and India has come in the sectors most open to foreign investment and competition. In Latin America, there is the example of fast-growing Chile—the country that began tariff reduction first and has pursued it the farthest, through several waves of unilateral tariff reduction.

12. The benefits to Mexico of NAFTA in terms of higher investment and trade have been enormous. But, as you in this audience well know, market opportunities are not static, and countries must continue to innovate and improve if they are to remain competitive. Further trade initiatives in the region—including the Central American Free Trade Agreement—help. But regardless of progress with the multilateral agenda, Latin America can, on its own, do much by reducing tariffs, limiting the use of non-tariff barriers, and relaxing restrictions on trade in services. Looking ahead, the challenge for the country is to produce efficiently those higher value goods that will deliver higher earnings and better living standards, rather than seek to hold on to low wage jobs.

13. Finally, the region needs a business climate that better encourages investment, innovation and job creation. International comparisons show that Latin America has been less attractive for foreign direct investment than other emerging regions, while domestic savings and investment also remain relatively low. Better governance, improved infrastructure and a reduction in regulatory barriers are important elements of a supportive business climate. In Mexico, for example, the World Bank estimates it takes 60 days to start a business—compared with 8 in Singapore and 9 in Turkey. Private and public monopolies were identified in a recent survey of Mexican entrepreneurs as a key market obstacle to business development. Progress in these areas is possible. China has moved ahead of the three largest countries in Latin America (Brazil, Mexico and Argentina) in the rankings of public institutions' quality compiled by the World Economic Forum. We have seen in the United States and elsewhere the critical contribution of new information technology to growth and productivity. In Mexico, businesses face higher telecommunications prices than elsewhere in the 30 OECD countries. Investment in a stronger infrastructure will also pay dividends. Just to give one example, with better transportation systems, Mexico could reap the full benefit of its proximity to the rich U.S. market.

14. The reforms I have suggested will take strong political will, and a broad national consensus, to put in place. Moreover, progress in one area may often depend on reform in another. As I mentioned, Mexico has made strides in financial and banking reforms. But these have not yet paid off fully in terms of rising credit for investment and growth. A strong banking system needs to be complemented by a predictable and efficient judicial sector. And when credit is available, businesses need a thriving market, skilled workers and a supportive and predictable environment. The good news is that reforms have begun. Mexico has recently overhauled its bankruptcy framework and enacted a new stock market law. Further steps will strengthen competitiveness and productivity, to support the higher incomes to which citizens rightly aspire

15. Successful reform strategies are possible. Experience around the world, including in some Latin American countries, suggests three related and mutually supporting elements of a successful reform strategy:

• First, strengthening public institutions to make them fairer and more accountable. In some countries, this will require civil service reforms aimed at ensuring a lean, well paid, efficient administration; as well as steps to enhance transparency—and trust in—the country's tax administration. Developing stronger and more independent institutions that combat corruption and promote the rule of law encourages savings, investment and job creation.
• Second, combining pro-growth policies with greater safety net protection can help sustain reform momentum. High levels of inequality in Latin America make it of particular importance to ensure that the benefits of new reforms accrue to the population at large. Policies to support job creation, such as labor market reforms, are key, together with well-targeted social programs, such as Opportunitades here in Mexico, that provide income support while also building human capital among the poorest.
• Third, building social and political consensus is essential to advance reform, including legislation where necessary. Swift action, while political capital is high early in the election cycle, can give time for economic benefits to materialize.

Concluding Remarks

16. In closing, allow me to emphasize again the opportunity Latin America today has to put the region on a fast growth path for the decade to come. As I have said in laying out my vision for the Fund over the medium term, which I had the opportunity to do yesterday in Mexico City, there is promise that this decade will see countries such as Mexico integrate ever more fully and successfully into the global economy. With a supportive global environment, and stronger and more responsible macro-management, many Latin American economies have already made significant gains in stability. The next step is to build consensus for those reforms needed to boost growth and spread the benefits of a stronger economy more widely than in the past. I am optimistic that Mexico can move in this direction. Today's conference is an important step in this direction.

Thank you very much.