Structural Reform and Growth Chong Sup Kim Objectives

Structural Reform and Growth Chong Sup Kim

Objectives v How much has the structural reforms in Latin America progressed? v Have the structural reforms contributed to the economic growth? v Is Washington consensus still a consensus? v What are the new views about the structural reforms?

7 6 5 4 3 2 1 0 -1 -2 1960 s 1970 s 1980 s 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 Economic History (%)

Economic History Import Substitution Economic Reform Resource Boom Debt Relief Debt Crisis Lost Decade 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1980 s 1994 1970 s 1993 1960 s 1992 7 6 5 4 3 2 1 0 -1 -2 1991 (%) Mexico’s Crisis Brazil’s Crisis Argentina’s Crisis

Washington consensus v Healthy fiscal position v Priority in public spending (education and health) v Tax reform v Financial liberalization v Competitive exchange rate v Trade liberalization v Openness to FDI v Privatization v deregulation v Respect to property rights

Sequence of the Reforms v At first stage n n n Stabilization Trade liberalization Financial liberalization v Later (or never) n n n Privatization Pension Labor market

Trade Liberalization

Tax Reform

Labor Reform

Current status of structural reforms v Although the reform process has not ground to a halt, it has been incomplete and uneven, both across countries and different areas of reform. v Greatest progress: trade and financial liberalization v Modest progress: tax reform and privatization v Most modest progress: labor reform

Structural reform index v The overall index is the average of the index in five areas: trade liberalization, financial reform, tax reform, privatization, and labor code legislation. v Progress measured in terms of policy variables, not in terms of results.

• Structural reform index for 17 LA countries rose from 0. 34 in 1984 to 0. 58 in the late 1990 s. • However, many countries have broad margin of unexploited potential for additional reforms.

v Reforms expanded the most between 1989 and 1994.

Reform fatigue v More and more Latin Americans started blaming the reform process for what they perceived to be a deterioration of their quality of life. v Reforms based of Washington Consensus were extremely successful in taming inflation, reducing government deficits and attracting foreign direct investment. v However, the results were more discouraging in terms of economic growth, poverty reduction and improvement in social conditions.

Dissatisfaction with reforms v Latinbarometer public opinion survey of 17 countries (2001) n n n 2/3 say that the economic conditions are bad or very bad. ¼ believes that the economy will improve in the future. ¾ believe that poverty has increased in the past five years. 63% believe that privatization has not been beneficial for their countries. Only ½ believe that democracy is the best form of government.

Dissatisfaction with reforms v The disillusionment of LA with structural reform has coincided with a time of economic stagnation and recession. For some observers, the situation today is proof enough that reforms have been ineffective. v However, factors other than the reforms influence economic performance, and the effect of the reform may appear uniformly across time. v A country with considerable privatization but little corruption tends to be placed in the upper area of the figure. v Privatization is considered to have failed to deliver benefits because of corruption.

Reform and growth v Until a few years ago, the prevailing view on the effects of reforms was very optimistic. n Lora and Barrera (1997) found that the reforms had an important and permanent impact on growth, productivity, and investment. (+1. 9%) v With updated reform indices, it was found that the reforms had only a temporary effect on growth.

Reform and growth v In 1991 -3, reforms accelerated annual growth by 1. 3% v When the reform process started decelerating, the growth effect dropped substantially. v In 1997 -9, it accounted for only 0. 6% of additional growth.

Performance in the 1990 s v Latin American countries have undertaken extensive macroeconomic reforms during recent years, but the growth rates achieved to date are considered to be inadequate with respect to several possible standards of comparison. v Why?

Possible explanations 1. Market-oriented macroeconomic reform has been the wrong policy prescription. 2. All that remains is to sit tight and wait. 3. The magnitude of the reform has been insufficient. 4. Reform had a restricted scope, institutional and microeconomic structural reform required. Unbalanced reform may create bottlenecks.

g = a. r(current) + a'. r(past) + b. c + s + t v The overall long-run growth contribution of reform, if it is sustained at the level r, is (a+a'). r. 1. 2. 3. 4. states that (a+a') is negligible. a is small but a' is large. reform itself(r) has been small (i) the contribution of r is bound to be small relative to the contribution of other policies underlying c and s. (ii) (a+a') depends on other variables outside of the scope of the current reform effort. This coefficient may be small in LA but would recover its normal level if the scope of reform is expanded.

v Eaterly, Loayza and Montiel proves that hypothesis 1 can be rejected. Also 4 (in slide 4). v Appendix Table 1 (2) : The presence of partial offset of the beneficial growth effect of stabilization and reform after five years, which is consistent with the cyclical patterns found in IDB. Hypothesis (2) can be rejected.

v The growth response to reform in the 1990 s has not been disappointing. In fact, taking into account policy dynamics, the observed growth acceleration in Latin America still exceeded expectations by an average of more than 0. 4%.

Results v Table 1. The contribution of stabilization and structural reform to aggregate long-run growth is 1. 84% per year. v Table 2. Comparison of LA 1991 -1995 & 1986 -1990: Growth acceleration due to macroeconomic reforms as well as some marginal improvements in education are partially clouded by a strong worldwide growth downturn of more than 1%. v Table 3. Comparison of LA and East Asia: Most (2. 52%) of the enormous growth gap (4. 58%) with East Asia is explained by incomplete reform (Hypothesis (3)). The educational deficit in Latin America is responsible for about half a point of the growth gap.

Institutional environment (? ) v The effect of reforms on growth and productivity is higher in countries with better institutional environments. v Reforms are more effective in countries with good rule of law. v Macroeconomic stability also important. v Moreover, the original reform process was too narrow.

The view from Washington v Washington Contentious(? ) v Marriage of equity with growth(? ) v Washington Consensus + n n n Monetary and fiscal institutions that can implement countercyclical policy and smooth the business cycle; Build social safety nets that trigger automatically; Decentralize education and improve access to education for the poor; Tax the rich more heavily and spend more on the poor; Protect workers’ rights; Implement a new generation of land reforms; + v Developed countries should play a key role in building a new financial architecture aimed at reducing volatility and contagion. v Increase the trade openness of developed countries.

The view from Santiago v CEPAL (Jose Antonio Ocampo) n n A new relationship between the market and the public interest. Economic policies should not be confined to the macro variables; More emphasis to the development of new productive activities, supported by active industrial policies, stronger regulation and a much closer cooperation between the government and the private sector; Development goals should not be restricted to economic growth and poverty reduction, but to a wider set of values, including freedom, social cohesion and cultural identity.

The view from Porto Alegre v World Social Forum (WSF) 2002 n n n Free trade does not guarantee wealth and development. Transnational corporations have too much power. Financial liberalization has increased global inequality and has been the main cause of financial crises and contagion. International financial institutions should be reformed. Developing countries’ external debt should be reduced and new lending mechanisms should be implemented.

Structural Reform and Growth