Speech

Adjusting to a Globalized Economy -- Address by Eduardo Aninat

October 13, 2000

Mr. Chairman, ladies and gentlemen, it is an honor to join you in your reflections on Latin America’s experience with market-based reforms. As the revolution in information technology in communications and services brings us closer together, we see unprecedented opportunities, in the form of higher growth, incomes, and job creation. But we also see unprecedented risks, in the form of highly volatile capital flows. And, I might add, in the evolution of political economy scenarios for sustaining the reform process.

This means that we must tread carefully if we are to reap the benefits but avoid the type of financial crises and political backlashes that a few years ago ricocheted around the globe, starting with the Asian crisis. What we are talking about is changing the way people interact and do business so that all people can prosper in our fast-changing world.

It was this very concern that preoccupied financial leaders when they met in late September in Prague for the Annual Meetings of the IMF and World Bank. For that reason, I found some of the slogans of the street protestors there quite baffling. “Our World is Not for Sale,” read one placard; “People Not Profit” read a banner hanging from a nearby bridge. Supposedly these are admonitions to reject globalization and now turn inward.

But why? On what intellectual basis? For whose benefit? Certainly not the poorest countries. For example, in 1997, the non-oil exports of Sub-Saharan Africa amounted to $62 billion. If these countries had merely maintained their market share in the commodities they were exporting in 1980, then 1997 exports would have been $122 billion, or double their actual level. By comparison, official aid (ODA) to Africa amounts to about $30 billion annually.

Since the 1980s, Latin America has rejected the option of turning inward—as have a large majority of countries worldwide—because to do otherwise, as we know from experience, would be to condemn the Region to more “lost decades” in the near future. In my remarks today, I would like to explore why openness is so crucial, and why countries should push ahead with privatization, another area where doubts have been raised. These are both critical components of the global reform agenda, yet both suffer from inadequate public support.

Critical to stay open

Lest there be any doubt that openness has not paid off, let me review just how far we have come. For the past 50 years, trade has been a major driving force in economic growth, with global trade expansion far outstripping global GDP growth. In the 1990s alone, world trade grew at an annual average rate of 6.8 percent, more than double world output growth of 3.2 percent per year. For developing countries, this meant trade growth of 8.3 percent per annum, contributing to real GDP growth of 5.5 percent yearly, and boosting the export/GDP ratio from 16 percent to nearly 22 percent today. For Latin America, this meant trade growth of 10 percent per annum, contributing to real GDP growth of 3.4 yearly, and boosting the export/GDP ratio from 10 percent to nearly 15 percent. Hardly discouraging numbers! Especially if one considers that the better paying jobs have arisen mostly in the Region’s tradable sectors.

Moreover, economists—creatures prone to “on the one hand ... and on the other hand”—mostly agree today that an outward-oriented development strategy is essential for achieving the sustained economic growth needed to raise living standards. Indeed, it is difficult to find evidence of a single country that has significantly raised living standards for its people, on a sustained basis, without sharply improving its trade and investment performance. Conversely, there is a large body of evidence that more open economies grow faster than closed ones, and that faster growth is necessary although not sufficient, to reduce poverty.

Which countries have done best in integrating their economies into the global trade system? Not surprisingly, it is those that pursued trade liberalization in a carefully phased manner and in the context of a comprehensive (domestically owned) development framework. In other words, just opening up the trade sector is not the full answer. Due attention must be paid to well-designed first- and second-generation reforms. The first-generation reforms are essential for establishing macroeconomic stability and rekindling growth. These include removing distortions in exchange rate systems; opening up trade and payments systems; removing price controls; and liberalizing production and marketing systems. Many developing countries have already succeeded with these reforms, or are well ahead with their implementation.

But it is the second-generation reforms that truly position countries for reaping the benefits of globalization, and it is these reforms that are proving far more challenging. They include reforming the financial sector, privatizing state enterprises, improving the quality and delivery of social services, rethinking the role of the state, and establishing and securing good governance practices (including transparency and accountability). After all, without decent health care, better education, and adequate infrastructure, it is extremely difficult to take better advantage of trading opportunities. And this issue applies to countries with very different backgrounds.

Uganda is an excellent case in point. It moved from a highly restrictive trade regime in 1985 to a very open trade regime by the late 1990s, first eliminating nontariff barriers, then lowering customs duties. The latter was facilitated by key reforms in the fiscal and financial sectors, based partly on substantial IMF technical assistance. Uganda also removed most price restrictions in agriculture, eliminated restrictive marketing boards, upgraded infrastructure, and diversified exports, and it is improving social policies (notably, the launching of universal primary education). As a result, from 1992-99, Uganda’s exports grew by an annual 16 percent, supporting real GDP growth of 7 percent per year, the country’s strongest growth performance on record.

Chile, if I might cite my own country, is another good example of the benefits of unilateral liberalization, an important tool from the “opening-up” reform list. During the 1990s, it lowered tariffs from 15 percent to 9 percent (scheduled to drop to 6 percent by 2003). It also adopted bilateral free trade agreements with a number of Latin American countries (e.g., Mercosur, Mexico) and with Canada. What was the payoff? As the agriculture sector became more export-oriented and profitable, it needed more imported technology. Also, imports of information technology and computers—now booming—contributed to enhancing human capital. Importantly, trade liberalization was part of a comprehensive reform program; in the social sector, this included compensation mechanisms for those hurt by trade liberalization, and the rebuilding of social institutions (such as pension reform). This combination, plus careful coalition building, helped maintain political support for trade reforms.

How about the trade barriers that developing countries still face? Wouldn’t it help if the industrial countries practiced what they preached, and opened up, particularly in areas where developing countries have a clear and demonstrated comparative advantage (e.g., agriculture, processed foods, textiles and clothing, and light manufactures)? It is estimated that a reduction in trade barriers by 50 percent globally, would yield welfare gains on the order of $400 billion annually for the global economy—with developing countries capturing one-third of these gains! That is why developing countries should push for a new global trade round, a “development round.” In the meantime, the IMF supports calls for the poorest countries to have duty- and quota-free access to industrial country markets. It also supports giving developing countries more credit, in future global trade rounds, for the unilateral steps they take.

Deregulating and privatizing

Of course, trade is not the only urgent item on the global reform agenda. Deregulation and privatization are others. Often, privatization is undertaken to change the role of the state from producer (usually an inappropriate role) to regulator (an indispensable role), and in the process, elevate the roles of private initiative, creativity, and market forces. The motivation can be budgetary (raising revenue and reducing political pressures for subsidies), and non-budgetary (economic efficiency gains, promoting investment, developing domestic capital markets, and combating corruption).

To be effective, however, it must be preceded by adequate institution building, and the establishment of an appropriate (modern) regulatory framework and rule of law. In other words, institutions matter! This pertains particularly to the privatization of “strategic” or “core” public enterprises, such as utilities, transport, and energy enterprises, all of which tend to be natural monopolies.

Indeed, this was the case in Chile in the mid-1980s, when legislation to develop a regulatory framework and institutional regulatory capacity was introduced, prior to the privatization of a number of utilities. This reflected lessons learned from the first round of privatizations in the mid-1970s. In the mid-1980s, the Government also helped generate public support and diffuse ownership by creating special incentives to allow workers to acquire and hold shares in the firms that were being sold. Then in the 1990s, the Government took privatization a step further by greatly enhancing the transparency of the process and strengthening the regulatory framework. All along, the emphasis has been on introducing competition—an approach that is neither pro-business nor pro-consumer, but pro-market. Privatization has certainly paid off in terms of better services, coverage, investment flows, and efficiency.

Sequencing also matters. To set the stage for privatization, macroeconomic policies typically need to be coordinated with institutional reform in key sectors—such as enterprise restructuring; creation of a commercially viable financial sector; and public sector reform, especially civil service reform. In Ukraine, for example, it would be difficult to design a macro program without tackling problems in the energy sector. At root is the extremely poor cash collection by utilities from consumers—only 15 percent was collected last year! This hurts their ability to honor tax liabilities and creates serious economic distortions. Last year, the state natural gas company “gave away” an estimated 6 percent of GDP by failing to collect on its bills. Moreover, this situation creates external problems with Russia; Ukraine is running up sizable natural gas arrears to Russia. And as arrears build up, Ukraine’s external debt position deteriorates.

Seize the moment

When is the best time for developing countries to undertake such comprehensive reforms? They would be well advised to seize the moment. The immediate economic outlook is the best in more than a decade, with global growth projected at 4 ¾ percent this year and continued strong growth next year. The strong U.S. economy has led the way, along with a pickup in growth in Europe, a firmer recovery in Asia, a budding recovery in Japan, and a rebound from last year’s slowdowns in several emerging markets. The transition economies are turning in their strongest performance since the start of the transition, led by the rapid recovery in Russia. And global inflation remains generally under control.

But there are also reasons for concern. Current oil prices, if sustained in the medium term, would hamper global growth and hurt prospects for many countries, especially the poorest countries highly dependent on oil. Moreover, among the three main currency areas, economic and financial imbalances still remain large, posing a risk to the global expansion.

How does Latin America fit into this picture? The outlook is better, with regional growth expected to reach 4 percent this year, accelerating to 4 ½ percent next year, after close to zero last year. Inflation is holding in single digits at 8-9 percent. There are also other key signs of progress:

• First, the rebound in growth is fueled by a strong expansion in export volumes, as recent currency depreciations have not fed back into inflation, thereby improving the competitiveness of the Region, unlike past opportunities when growth was fueled merely by favorable terms of trade.

• Second, the Region is enjoying large net private capital inflows, with foreign direct investment—which tends to bring with it the bonus of new technology and knowledge transfers—accounting for slightly more than half of the inflows.

• Third, there is more economic stability—in growth, prices, current account balances, and capital flows—even taking into account the two episodes of financial turmoil that hit the Region. Stability gives governments needed space to focus on actions needed for the longer run.

But behind this improved overall outlook for Latin America lies the increasingly mixed performance of different countries, with growth surging in some while remaining very weak in others. Mexico tops the list with a growth rate of 6.5 percent—6 percentage points higher than in Ecuador and Uruguay—this year. The wide range stems partly from different institutional and political situations. But it also reflects different trade positions (oil is a major factor) and sharply diverging degrees of advance with policy reforms.

Ensuring that all benefit

The upbeat outlook for the Region also glosses over social ills. Although the 1990s saw a reversal in the poverty trend, undoing the rise of the 1980s, poverty remains disturbingly high—with almost 185 million people living on less than $2 per day. Moreover, little progress has been made in reducing heavy income inequalities in the Region. In Honduras, for example, the income captured by the lowest 40 percent of households rose by only 2.1 percent in the 1990s.

So what can be done? Latin America’s best hope lies in much higher economic growth rates; for the weakest performers, sustained rates of 6-7 percent are required to make more satisfactory progress against poverty. For we know that growth is by far the most important source of poverty reduction, and it is a vital source of financing for targeted social outlays. In Chile, for example, during the 1990s, four-fifths of the 50 percent increase in real per capita social outlays achieved, emanated from higher growth. And during this time period, Chile managed to cut the poverty rate by one-half. Yes, by one-half in only nine years!

This also points to the importance of investing heavily in human capital—especially education—as we transit towards the “knowledge economy.” For many decades, the Region has focused on increasing educational coverage, especially in primary schooling, with great strides being made. Now policymakers need to make a dramatic switch and focus on improving the quality of education, as Chile has done. Its curriculums are being overhauled, new and better teachers are being recruited, and schools are benefiting from new equipment. In fact, all high schools, and more than half of the primary schools now have computers complete with direct links to the Internet. These reforms should help strengthen the link between economic growth and equity, since public schools are usually attended by children from low- and middle-class families.

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In closing, I would emphasize that keeping markets open and investing in our people hold the key to unlocking future prosperity—for all—in our increasingly globalized world. Developing countries in particular must continue to resist temptations to turn inward, or the gap between rich and poor countries will widen further, leaving large chunks of the world behind.