Brave New World for Latin America

Marcelo M. Giugale

In 2009, Latin America dodged a bullet. Its efforts over the previous decade at better economic management and smarter social policy paid off, and the worst global recession in a generation caused only minor damage. Does this mean that the region will go back to business as usual, back to a commodity-fueled bonanza, back to la vida loca? No, it does not. The crisis has opened both challenges that policy makers will be forced to address and opportunities they will be foolish to ignore.

This [text] describes those challenges and opportunities and uses them to visualize how the region’s economic policy agenda will change over the coming years. It does not focus on all the issues that will be relevant, but on those that will be relevant and different. Specifically, it will argue that six new issues will appear on the radar of Latin American policy makers:

  • fiscal decision making that smoothes, rather than exacerbates, business cycles;
  • a profound preoccupation with innovation as a means to commercial survival;
  • adaptation to a changing regulatory wisdom in finance;
  • the shifting of social policy from equality to equity;
  • the use of results to rebuild trust in the state; and
  • the realities of having a bigger role in world affairs

Not all Latin American countries will move along the new agenda at the same speed. A few have already started, and a few may even go for a while in an opposite direction. Overall, however, the picture that emerges is one of second-generation policies, a reflection of well-managed economies making the most of a promising development horizon.

Independent Fiscal Agencies

The global financial crisis has shown the wisdom of governments that save in good times to spend more during downturns—the wisdom of “countercyclical fiscal policy.”1 That simple principle brought huge economic and political rewards to those that practiced it (see Chile). But it did more than that. It opened the door to a new way of thinking about public finance. Much as in the early 1990s, when worries about inflation led many Latin American countries to stop printing money to pay for fiscal deficits and to shift control of the printer to an independent central bank, worries about unemployment may now lead them to link taxation and public investment to growth. In the 1990s, half a dozen Latin American countries adopted “inflation targets” and met them. The time for more independent fiscal decisions that take into account “growth targets” cannot be far away.

Will independent fiscal agencies become common in Latin America? Probably. But they will have advisory, rather decision-making, roles. That is, they will be fiscal “councils,” rather than fiscal “authorities.” In fact, two councils already exist (in Brazil and Chile), mostly in the form of technical support for parliaments. As more countries in the region implement fiscal frameworks or fiscal responsibility laws (some 10 already have), independent monitoring will become a necessity, both to judge the realism of budget projections and to hold governments accountable during execution. To some extent, private organizations (for-profit and not-for-profit) have been providing that kind of monitoring service for a while. As pressures mount for fiscal policy to be, and be perceived as, countercyclical, the role of fiscal watchdog will become institutionalized within the apparatus of the state, but outside the control of incumbent governments.

An additional force may be pushing for independent fiscal opinions: the continuing accumulation of commodity-related revenues. In the baseline global scenario, growth in Asia will keep commodity demand strong and commodity prices high. Volumes may also increase, driven by recent discoveries of oil and gas (in Brazil and Colombia). This will translate into fiscal abundance for many Latin American countries. If that happens, some of those monies will have to be saved in sovereign wealth funds, whose rules of operation will be the subject of much debate. Having independent agencies monitor the application of those rules and, at times, provide technical inputs (for example, in forecasting prices) will become a more accepted practice—and a way to avoid political meddling.

Innovate or Perish

Successful Latin American countries will have to learn to live with appreciated currencies. With interest rates in the developed world likely to stay floor-low for a while, money will continue to flow into the region’s more promising economies. This will make them less competitive. There is not much they can do about it—accumulate reserves, impose capital controls and taxes, keep banks from credit sprees, and increase productive efficiency. But those are either unsustainable measures or long-term reforms. The reality is that living in, or exporting from, places like Bogotá, Lima, São Paulo, or Santiago will be more expensive in U.S. dollars. It will be more difficult to sell Latin American products in the United States and in any other country that keeps its currency tied to the U.S. dollar, notably China. That is why success in trade will now depend more on new products. While securing additional free trade agreements will still be beneficial, creating new brands will be even better.

The problem for Latin America is that, on the whole, it has not excelled at innovation. It invests too little in research and development, provides few tax incentives, and does not protect intellectual property well, and its universities are disconnected from its businesses. This is reflected in minute levels of patent registration, declining total factor productivity (vis-à-vis the U.S. benchmark), few firms’ acquiring of quality certifications (less than a quarter), and a commercial penetration that has been stagnant for decades (only about 5 percent of world trade has a Latin American partner). Even the precrisis years of abundant financing saw only a handful of new Latin American business lines come to market—premium foods, medical tourism, aeronautic engineering, software development, and call centers.

It will take years to fix those problems, but the new global reality will make change unavoidable. Will there be a single formula to foster innovation in Latin America? No. Latin American countries differ in terms of technological stock, efficacy of tax systems, quality of human capital, legal predictability, and institutional capacity. But successful innovation strategies show some common features that point the way forward:

  • They are priorities of the state (they do not change from government to government)
  • They are not based solely on markets
  • They engage all relevant stakeholders (big and small, public and private)
  • They hold someone accountable for results
  • They are part of a broader effort of integration
  • They are well funded
  • They are continuously evaluated and adjusted
  • They begin with quick wins (usually in the area of quality standards)
  • They include reforms in tertiary education
  • They operate within a reliable legal framework

Interestingly, more private innovation in Latin America will call for better public action. From venture funding to skill improvement, the state will have a new role to play. Rather than taking the exclusive leader-ship as it tried in the past (with poor results), it will become a catalyzing partner in multi-agent efforts. In some cases, it will contribute resources; in others, it will contribute reforms.

Reinventing Finance

Latin America will be wary of fancy finance. Its banks and bourses sailed through the crisis rather well. There were no subprime surprises in Latin America. In part, that is because its financial sectors are small, unsophisticated, and with limited external connections and, in part, because Latin America still regulates them in a heavy-handed, old-fashioned way. In addition, the remaining publicly owned banks came in handy to keep credit flowing. Meanwhile, the developed world, shocked by the excesses in Wall Street, entered a wide debate about new ways to control financiers without killing their creativity. From how much capital banks should hold to how much bankers should be paid and from who is “too big to fail” to how savers should be protected, it is all up for discussion. Over the next couple of years, governments in the region will have to decide how much of the new thinking to adopt, adapt, or avoid.

In practice, regional policy makers will be dealing with financial issues at both ends of the technical spectrum. On the one hand, postcrisis second-generation questions will have to be addressed, like countercyclical regulation, systemic risk, and nonbank intermediaries. On the other hand, a long list of basic but critical matters that preceded the crisis remains pending, especially in terms of competition and efficiency, access by the poor, and underdeveloped equity markets.

That policy dichotomy will play out at a time when Latin America’s financial sector will be under pressure. In the short term, and as described earlier, foreign capital inflows will be abundant. Much of these inflows will be reflected in excess liquidity among domestic banks and in larger domestic lending. Some will flow into the regional equity markets, which, given their relatively small size, may quickly experience a surge in prices. In both cases, the domestic financial sector will be exposed to sudden capital flow reversal. Regulating this risk away will not be easy.

A different challenge emerges in the medium term. The region’s largest countries are expected to continue experiencing surpluses in their balance of payments current accounts, led by high commodity prices. The counterpart of those surpluses—large domestic savings—will need to be intermediated. In other words, the balance sheet of Latin America’s financial system will expand considerably. Whether this fosters consumption or investment, at home or abroad, by the public sector or by the private sector, will depend on the regulatory parameters under which the system is made to operate. In the recent past, markets could be relied upon to set some of those parameters (for example, through credit ratings); however, the crisis has de facto shifted that responsibility almost entirely back to governments.

Equity: More than Equality

Latin America has learned the value of knowing the poor by name. An estimated 8 million Latin Americans fell into poverty in 2009, and about 5 million missed their chance to leave poverty behind. Those are unfortunate numbers, but, compared to past experience, they are very small. What sheltered the region? It avoided jumps in inflation, so people’s purchasing power did not melt. But more remarkably, for the first time, Latin America had effective mechanisms to protect the poor. Thirteen Latin American countries had spent the previous decade identifying the poor one by one and setting up channels to transfer cash to them directly—not an easy task given that the poor rarely have bank accounts or even postal addresses.2 This has provided a platform for the next big move in Latin American social policy: to focus on equality of opportunity, on giving everybody the same chances rather than the same rewards, on equity rather than equality.

Latin America remains the most unequal region on Earth. Inequality dominates virtually all its development outcomes—income, educational achievement, and landownership. Taxation and public expenditures have made little difference in addressing the problem.

The result has been acrimonious political disagreement over the proper role of the state: should it redistribute wealth or protect private property? This has weakened confidence in the region’s legal security, to the detriment of long-term investment. There is no disagreement, however, over the need to give all Latin Americans the same opportunities, as a matter of social justice or as a call to personal effort. Equity enjoys support across the political spectrum. The problem was that it had never been possible to systematically measure inequality of opportunity, in Latin America or anywhere else. The development profession simply lacked the methodological tools to monitor equity, making it all but impossible to design, implement, and evaluate public policies that target human opportunity.

That changed in 2008. A new technology to measure human opportunity—the Human Opportunity Index (HOI)—became available, the creation of a team of Latin American researchers. In essence, the HOI calculates how personal circumstances (like gender, skin color, or family income) impact the probability a child has of accessing the services that are necessary to succeed in life (like timely education, basic health, or connection to electricity).

The HOI, combined with the data and logistics embedded in the direct cash transfer programs that Latin America now has, will make it possible to redirect social policy toward equity (where there is consensus) and away from equality (where there is not). How? Many existing social policies and programs are already equity enhancing. But the focus on equity reveals new points of emphasis along the individual’s life cycle. Early interventions, from pregnancy monitoring and institutional births to toddlers’ nutrition and neurological development, get a new sense of priority. So do preschool access (such as pre-kindergarten social interaction) and primary school achievement (such as reading standards and critical thinking). The physical security, reproductive education, mentoring, and talent screening in adolescents, all areas that are often overlooked, gain new relevance. A battery of legal and institutional preconditions become sine qua non, from birth certificates, voter registration, and property titles to the enforcement of antidiscrimination, antitrust, and access-to-information laws. And blanket subsidies that, at the margin, are consumed by those who do not need them (free public college education for the rich, to name one), turn into opportunity-wasting aberrations. If nothing else, the quest for equity will lead to a final push in the decade-long process of subsidy focalization and will spell the end game for a way of giving out public assistance that was blind to the needs of the recipient— a way that was intrinsically unfair.

Trust the State

From now on, people will demand a lot more of the state—to spend more, to regulate more, to protect more. Trust in free markets has been damaged. But Latin Americans never really trusted the state anyway. That is why they refuse to fund it and remain trapped in a vicious circle of tax evasion and deficient public services. Even progress in fighting corruption (which, unheralded, has occurred) has not done much to rebuild the relationship between the state and the people.

That will need to change soon. Technology and politics will help. New ways to hold public institutions accountable have been penetrating the region for a while, initially among municipalities and provinces, where mayors and governors are in closer proximity to voters. There are now standards to measure the quality of education, infrastructure, security, and any other public service. How many words per minute should a second grader read? At least 60. How much should the cost of logistics be for every dollar exported? No more than 10 cents. What should be the “normal” annual homicide rate? Three for every 100,000 people. The list goes on. Few services in few Latin American countries are, of course, up to par. But political leaders who have committed publicly to these kinds of results do very well in the polls (Brazil, for example). Others will surely follow. The average Latin American state will be increasingly managed and judged by the results it achieves.

There will be another force pushing the state toward results-based management—devolution. Ushered in by the return of democracy in the 1980s, Latin America entered a rapid process of decentralization in the mid-1990s. Tax and expenditure responsibilities were delegated to provinces and municipalities. The quality of public services did not always improve. But decentralization proved popular and is bound to deepen. At the same time, the new ways to do social assistance described earlier showed the possibilities opened by the state’s ability to communi- cate with, and transfer resources to, individual citizens. On a simple mag- netic card or even a cell phone, the state can transfer directly to the beneficiary the funds to buy, or the right to access, almost any service, from vaccination to college education. There is no longer a need for inter- mediaries. Decentralization will be gradually moving down to the citizen level; in a way, it will become devolution. This new, direct relationship between people and the state is generating, and will continue to generate, a wealth of information—about costs, quality, targeting, needs, outcomes, and impacts. Monitoring and evaluation of policies and programs will be much easier. And management by results will become natural.

A Global Player

The 2009 global financial crisis created new forms of external support and integration for Latin America. Its multilateral lenders were promised larger lending capacity and fairer representation. Flexible financing for good performers was quickly offered. The G-20 brought Argentina, Brazil, and Mexico to the table where the decisions that will shape the world will be made. In the redesign of financial regulation, the next round of trade negotiation, or the efforts to slow climate change, Latin Americans now have a better opportunity to be heard. They will also count in the rebalancing of the global matrix of saving and consumption; after all, their consumption is larger than China’s in absolute dollar terms and as a proportion of gross domestic product. The region is even seeing the emergence of its first, own global leader—Brazil.

But the region’s contribution to the global commons will go further. A new generation of former national leaders has left, or will soon leave, office in success and popularity (including Brazil, Chile, Colombia, Costa Rica, Mexico, and Uruguay). Playing by market rules but listening to their people’s needs, they delivered prosperity and social progress for their countries. Their governments have not only done well using traditional policy tools, but also pioneered new ones (for example, structural fiscal balances and conditional cash transfers). They are now credible spokespeople for good administration and are much sought after on the international conference circuit. They have become global assets that will give the region a new voice.

This new relevance will bring new disciplines and will reinforce others. It will be more difficult for Latin American countries to backtrack in trade and financial openness, and more painful to lose investment grades. Worldwide rankings will have larger domestic impact (call it “the embarrassment factor”), from those dealing with public transparency to those dealing with the quality of the business environment. And light may begin to shine on long-postponed reforms, without which the benefits of integration are diluted—notably, in education and infrastructure.

Conclusion: If the World Holds, Latin America Will Take Off

The alignment of domestic and external factors augurs well for Latin America’s future. Macroeconomic and financial discipline, combined with smarter social policy and a more responsive public sector, may not yet be universal values in the region, but an increasing number of countries are adopting them as part of their development strategies. Latin American voters have begun to reward sensible policy making. At the same time, the rapid growth of the middle classes in Asia should ensure high long-term prices for what Latin America sells. If well managed, this “commodity platform” could be the stepping stone for the region to upgrade its productive capacity, especially its human capital, and expand its brand beyond natural resources.

Are there downside risks? Yes, many. Most come from the global economy. The recovery could be a slow, protracted process, dragged down by balance-sheet adjustments (for example, in mortgage markets) or second-round effects (for example, persistent unemployment). Commodity prices may dive if the liquidity injected by the G-84 during the crisis is rolled back too quickly, or if China’s domestic consumption does not compensate for the return of its public investment to prestimulus levels. Massive fiscal imbalances in the United States will not be easy to correct, hinting at much higher interest rates (or dollar inflation or both) in the near future. A downgrade of sovereign debt among developed countries could trigger a flight to safety and away from emerging markets. And there are plenty of uncertainties at home: specific countries could still run into overheating and high inflation, breakdowns in internal security, or political turbulence.

Any of those risks could derail Latin America’s growth, at least for a while. But for the first time in decades, its fundamentals look solid and the horizon promising. In the base external scenario, and with variations across countries, the region as a whole is converging on a path of sustained development.


1.    The crisis also showed the wisdom of building agile public investment systems. Several countries (Brazil, Chile, Colombia, and Peru) quickly embarked on strengthening those systems.
2. The process of identifying the poor forced a parallel process of integration of individual social records across ministries and agencies. This should further facilitate tailoring social programs to a person’s needs.
3.    Members of the G-20 are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, the Republic of Korea, the Russian Federation, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United States, and the European Union.
4. Members of the G-8 are Canada, France, Germany, Italy, Japan, the Russian Federation, the United Kingdom, and the United States.


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