Bad luck or wrong policies? External shocks, domestic adjustment, and the growth slowdown in Latin America and the Carribean

Samuel Morley, Rob Vos

Research output: Working paperAcademic

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Abstract

Since the late 1980s, almost all Latin American countries have gone through a
process of far-reaching economic reforms, featuring in particular trade, financial and
capital account liberalization. Economic opening has gone hand in hand with large
financial inflows, particularly in the first half of the 1990s. Increased openness has
brought new sources of economic growth but it has also increased volatility and
sensitivity to external shocks. At first the reforms seemed to be working as promised.
Economic growth increased, inflation declined and there was a big surge in foreign
capital inflows. But somewhere around 1995 or thereabouts, growth faltered,
particularly in the countries of South America. So did exports.They had been expected
to be the leading sector in the post reform growth model, but unlike the Asian
experience export-led growth in Latin America has proved so far to be anything but a
development miracle.
This paper analyzes growth trends and the vulnerability to external shocks of
the countries in Latin America and the Caribbean over almost a quarter of a century
since 1980.1
It is shown that as a consequence of the process of economic opening to
world markets, growth has become export-led in virtually all countries of the region.
However, unlike the experience with export-led growth in East Asia, Latin America’s
new growth strategy seems to come with a number of less virtuous characteristics.
First, while more reliant on exports, economic growth did not significantly increase
after trade opening. Instead, growth slowed down and economic performance was
worse in the second half of the 1990s as compared to the first and most countries
slipped to negative per capita income growth at the turn of the century. Second,
vulnerability to fluctuations in global commodity markets (i.e. terms-of-trade shocks
and volatility in global demand) remains high and is a first indication of insufficient
diversification of trade. This vulnerability to trade shocks cannot by itself explain the
dismal growth performance, as in fact for most countries terms of trade and world
demand for their exports improved during the 1990s.
Third, for most countries of the region export growth has been below that of
world trade, implying lower export penetration in global markets as a result of losses
in competitiveness. At the same time, import dependence has risen more strongly than the capacity to export. As a result, capital flows have become more important to
sustain a growth path built on this paradoxical combination of increasing reliance on
exports and a structural rise in the trade deficit. Capital flows in turn have both
initiated (to the extent exogenous) and reinforced this pattern by pushing up real
exchange rates, cheapening imports and squeezing profits for exporters in the short
run. As capital flows themselves have been volatile, to a large part for reasons
exogenous to economic conditions of the countries of the region, macroeconomic
adjustment has become more difficult to steer and resulting in short-lived booms as
access to foreign borrowing eases and demand deflation as it contracts with important
implications for employment and wages. The impact of economic reforms, such as
further trade liberalization in the context of WTO or the Free Trade Area for the
Americas therefore must be studied in conjunction with such macroeconomic
constraints.
Original languageEnglish
Place of PublicationDen Haag
PublisherInternational Institute of Social Studies (ISS)
Number of pages48
Publication statusPublished - Jun 2004

Publication series

SeriesISS working papers. General series
Number398
ISSN0921-0210

Series

  • ISS Working Paper-General Series

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