Inter-American Development Bank Dealing with an Research Department Volume 18 International Crunch January–April, 2009

ealing with an international credit crunch tions come to mind: Can emerging countries IN THIS ISSUE is no easy task, as any policymaker in the afford expansive monetary and fiscal policies Dworld would tell you today! Credit flows in times of crisis? Should they instead restore Chile: are the blood of the world’s economic system. credibility by tightening monetary and fiscal Banking on Policy When a human artery becomes clogged and policy, or will these policies only make mat- Credibility 3 the blood flow is interrupted, the consequences ters worse? To what extent are weak initial can be dire unless the flow is restored prompt- macroeconomic conditions an important Peru: ly. Similarly, a sudden stop constraint leading to Where Reserves in capital flows that blocks disaster? Do they put a Saved the Day 4 the normal supply of inter- There is no substitute country on an irreversible national credit to countries path? Are they destiny, Brazil: can inflict serious damage for taking advantage or can their impact be A Two-Pronged on the affected economies mitigated during a crisis? Strategy for Solvency 6 unless decisive action is of periods of external Should financial shocks taken. But if you’re not a be viewed as temporary Applying the government like the Unit- bonanza to improve or persistent, and what Past to the Present 7 ed States, a safe haven for policy options are avail- global savings that can macroeconomic able? And further down pump billions of dollars the road, what implica- New Publications 8 into a stimulus package, fundamentals at home. tions does the latent risk what’s a country to do? of sudden stops have for Look Who’s Talking 11 This newsletter looks economic policies during at this question from the Latin American point periods of bonanza? Network News 12 of view. Drawing from research that explored This newsletter draws from a new IDB the region’s experience with the sudden stops book, “Dealing with an International Credit in capital flows of the 1990s, it reviews les- Crunch: Policy Responses to Sudden Stops sons learned that may be of use today. To in Latin America,” which addresses these AVAILABLE NOW! begin with, countries must realize that it’s questions from different angles, bringing not necessarily their fault. A defining charac- in both lessons from country studies as teristic of systemic sudden stops is that they well as cross-country analysis. The book originate in shortcomings in international documents policy responses to sudden stop capital markets—i.e. international capital sup- episodes of the late 1990s for eight Latin ply shocks—rather than in domestic policy American countries. But it also takes a failings. However, while the cause may come more systematic approach by analyzing the from abroad, the solutions must often be home impact of policies on output behavior for grown and if sudden stops are not handled a wider range of emerging markets. Using adequately, then output collapse can be severe both sets of information, and distinguish- and recovery more painful. ing between successful and unsuccessful In designing a strategy to confront sudden cases, it extracts policy recommendations http://www.iadb.org/res/pub_desc. Continued on page 2 stops and avoid output collapse, several ques- ▼ cfm?pub_id=B-633 Ideas for Development in the Americas . Jan – Apr., 2009

Dealing with an International Credit Crunch ▼ from page 1

for countries that might face a sud- Figure 1. Initial Conditions and Output Declines den stop in the future. As the world teeters on the brink of a major global Weak with potentially MEX severe consequences for emerging economies, the issues addressed in

this volume come back to the fore- URY front of the policy debate. ARG PER The book presents the following ECU main conclusions: Initial Conditions BRA COL

• Expansionary fiscal and monetary CHL policy that does not affect cred- Strong 0 246810 12 14 16 18 20 ibility or solvency can reduce out- put collapse in the aftermath of a Output Drop (%) sudden stop. Countries that were Source: Calvo, Izquierdo and Mejia (2008). Systemic Sudden Stops: The Relevance of Balance-Sheet Effects and Financial Integration able to adopt more flexible fiscal and monetary policies in the after- math of a financial crisis had a loss crucial—countries need to be able ent levels of preparedness and may in output of less than 5%, while to afford these policies. seriously limit policy options. There nations with much less flexibil- • Initial conditions matter: the same are no good substitutes for reducing ity had output contractions above shock can have different conse- vulnerabilities during good times to 10%. However—and this is really quences in countries with differ- confront the possibility of bad times in the future. For example, suc- cessful anti-cyclical policies during financial crises work when govern- This issue of IDEA was prepared by Eduardo Cavallo and Rita Funaro. It is based on ments are prepared to boost spend- the research of Paul Castillo, Daniel Barco Rondón, Márcio Garcia, Alberto Ortiz, ing in a sustainable way—for which Pablo Ottonello, Federico Sturzenegger, Ernesto Talvi and Rodrigo Valdés as presented they need to have saved before. And in the book Dealing with an International Credit Crunch: Policy Responses to to conduct looser monetary policy Sudden Stopos in Latin America, edited by Eduardo Cavallo and Alejandro Izquierdo. that does not fuel or lead to balance-sheet problems in either Eduardo Lora Rita Funaro the public or private sectors, a coun- General Coordinator Managing Editor try must have avoided the dollariza- IDEA (Ideas for Development in the Americas) is an economic and social policy tion specter during the boom years. newsletter published three times a year by the Research Department, Inter-American (Figure 1 illustrates how countries Development Bank. Comments are welcome and should be directed to IDEA’s man- that enjoyed strong initial conditions aging editor, Rita Funaro at [email protected]. limited the contraction in their eco- The views expressed herein are those of the authors and do not necessarily represent nomic output during a sudden stop.) the views and policy of the IDB. Articles may be freely reproduced provided credit is • Initial conditions are not destiny: given to IDEA and the IDB. To receive the newsletter electro­­nically, please send your even if they haven’t done all their e-mail address to: [email protected]. Past issues of this newsletter are available on homework, countries still have the Internet at: http://www.iadb.org/res/news. means at their disposal to weather the storm. A targeted use of interna- tional reserves during an internation- al credit crunch—for example, sup- Inter-American Development Bank Continued on page 5 ▼

2 Jan – Apr., 2009 . Ideas for Development in the Americas

Chile: Banking on Policy Credibility

eing prepared pays off. That is factors also weighed heavily. Chile demand and regulate the deprecia- one of the big lessons of the had (and continues to have) strong tion of the exchange rate became BChilean experience with the fiscal institutions ranging from a of paramount importance. Contrac- sudden stop in capital flows in 1998. centralized state and a strong Minis- tionary monetary and fiscal policies Hit by the retrenchment of capital try of Finance to arrangements such were the government’s initial policy flows following the Asian crisis and as a copper price stabilization fund response. a decline in its terms of trade due to that allows the authority to set aside In a way, the policies were almost a drop in copper prices, Chile’s net abnormally high copper revenues in too successful. The combined effect capital inflows plummeted from the a transparent way. of the external shocks and poli- equivalent of 7% of GDP in 1998 to cies was an unexpectedly large and less than 1% of GDP in 1999 while quick adjustment. Imports of goods capital outflows reached $1.5 billion. and services transited from grow- But instead of an economic collapse, The macroeconomic ing 16% year-over-year in second Chile suffered a small quarter 1998 to sliding 14% in the thanks to a strong financial system, framework and final quarter of the year. Behind this healthy public finances and a flex- adjustment was a sudden decline in ible policy apparatus. conditions that Chile domestic demand of almost 8%. Throughout the 1990s, Chile This overcorrection highlights laid the groundwork for strong had built over a another important lesson. When monetary and fiscal policies. With in the eye of the storm, it is often the objective of maintaining price decade served it well difficult to assess the true nature stability, the of Chile and duration of a crisis. Chilean used annual inflation targets as the authorities initially misjudged the predominant nominal anchor of the in the face of the type of shock at hand. However, economy. Annual announcements policymakers were able to bank aimed at ever lower inflation. An sudden stop. on previously earned credibility to exchange rate band system sought shift gears and accommodate the to maintain the current account shock with expansionary policies deficit within sustainable levels and In addition to strong monetary before it was too late. By changing the Central Bank intervened in the and fiscal policies, the Chilean econ- course, they were able to keep the foreign exchange market not only omy also enjoyed strong financial economy from slipping into a deeper at the edges of the band, but also institutions. Following the collapse recession. actively within it. From a rather of the banking system in the fallout The macroeconomic frame- rough management of interest rates to the crisis of the 1980s, Chile work and conditions that Chile had on instruments of different tenors worked hard to improve financial built over a decade served it well in in 1990, the Central Bank advanced regulation and supervision. These the face of the sudden stop. Hav- to managing liquidity in order to changes allowed for the development ing capitalized, well regulated and achieve a particular overnight inter- of a healthy and resilient financial supervised banks made it possible to est rate in the interbank market (the system. follow a very contractionary mon- target being the monetary policy When the crisis hit, Chilean etary policy during the first phase ). Throughout the decade, authorities were in the midst of try- of the crisis without overly jeopar- fiscal policy too was well-managed, ing to tame an overheated economy. dizing the health of the financial allowing the central government’s As the external shocks hit, the cur- system. And avoiding liquidity risks net public debt to decline from rent account deficit widened, the in government financing let authori- 37.6% of GDP in 1989 to 5% in exchange rate came under pressure ties boost interest rates substantially 1997. Strong growth certainly facili- and fiscal revenues declined; the and pump prime the economy later tated this result but institutional need to control galloping domestic to prevent a collapse.

www.iadb.org/res 3 Ideas for Development in the Americas . Jan – Apr., 2009

Peru: Where Reserves Saved the Day

obody’s perfect. Peru did a lot Figure 2. Domestic Liability Dollarization: Selected Latin American Countries of things right during the 1990s but it had at least one critical N Domestic Liability Dollarization Measure Before the Crisis flaw that made it highly vulnerable in the context of the 1998 sudden stop in COL capital flows: a high degree of finan- CHL cial dollarization. Still, the Peruvian BRA experience teaches that bad initial ECU conditions do not necessarily deter- MEX mine a country’s destiny. In spite of its ARG dollarization, Peru emerged relatively PER unscathed from the sharp decline in its URY terms of trade and the repercussions of 0% 10% 20% 30% 40% 50% 60% the Asian crisis thanks in large part to % of GDP savvy management of its extensive for- eign reserves. Net Domestic Liability Dollarization Measure Before the Crisis Throughout the boom years of CHL the early 1990s, Peruvian authorities COL prepared to meet unexpected foreign currency outflows by building up a pro- BRA tective shield of international reserves. PER How did it amass one of the largest ECU levels of international reserves in Latin ARG America? To begin with, it established MEX a high marginal URY ratio that allowed the banking system –30% –20% –10% 0% 10% 20% 30% 40% 50% to accumulate some $3.7 billion in % of GDP reserve deposits by 1997. Secondly, by Sources: Calvo, Izquierdo, and Mejia (2008). reducing inflation from over 7,000% to just 6.5%, the government restored credibility in the domestic currency and progressively absorbed the reduced credit crunch. In spite of its high degree for eight countries in Latin America demand for foreign currency. Finally, of financial dollarization, Peru avoided on the eve of the Asian crisis. The the Central Bank added substantially a financial crisis with a combination of upper panel, showing the gross DLD to its international reserves with pub- lender-of-last-resort policy in foreign position of each country, indicates lic sector deposits, mainly from the currency and exchange rate policy that that Peru fared worse than Argentina proceeds of an extensive privatiza- limited volatility in the exchange rate. in this dimension. The lower panel tion program. The result was that by By pumping foreign currency reserves shows instead the net DLD position— the end of 1997, Peru’s international into the banking system, the monetary DLD minus foreign exchange reserves reserves represented 78% of the total authorities staved off the failure of those as a share of GDP. Clearly, Peru’s banking sector’s liquidity and almost banks that were more indebted and in large stock of international reserves 18% of GDP. this way prevented domestic banking accumulated during the preceding As important as the quantity of credit from drying up entirely. period of economic expansion was an international reserves stashed away in Figure 2 plots the level of gross important element in diminishing the government coffers was the Peruvian domestic liability dollarization (DLD) country’s vulnerability to the dollariza- government’s willingness to use them —basically dollar loans in the domestic tion specter. to provide dollar liquidity during the financial system—as a share of GDP ▼ Continued on page 5

4 Jan – Apr., 2009 . Ideas for Development in the Americas

Peru: Where Reserves Saved the Day ▼ from page 4

However, effectiveness in the use Although the role of its inter- countercyclical fiscal policy that pre- of international reserves may depend national reserves was crucial to its vented negative GDP growth rates and on the particular instrument chosen. success, there are other aspects of helped avoid a larger depreciation of The Peruvian experience shows that Peru’s preparedness that contributed the real exchange rate. Being able to direct and permanent injections of for- to the resilience of the economy to spend during the sudden stop episode eign liquidity—in this case, through the crisis. The fiscal reforms of the kept the Peruvian economy moving a continuous reduction of the aver- early1990s successfully pared down while the economies of many of its age and marginal reserve requirement the large fiscal deficits that had neighbors came to a screeching halt. ratios—were more effective to offset plagued the country during the 1980s. The 1990s was also a period of the negative effects of the sudden In turn, the improvement in Peru’s fis- massive investment in Peru, particularly stop on the banking system than the cal position had far-reaching effects in the tradable sector. One of the main direct sale of foreign currency on the on its macroeconomic stability. Initial- objectives of the structural reforms exchange market. This is so because ly, it contributed to the accumulation of the 1990s was to provide a macro- direct injections of foreign liquidity of the Central Bank’s international economic environment that promoted allow banks to boost liquidity in for- reserves and government liquidity investment. Policies favoring private eign currency without reducing their in the financial system. Later, those investment were complemented by

liquidity in domestic currency. funds were fundamental to finance a ▼ Continued on page 7

Dealing with an International Credit Crunch ▼ from page 2

porting export credit lines—might IMF withdrew support in November and soaring commodity prices, others be a more effective use of available 2001. Argentina’s vulnerability made remained wary of cycles in the inter- resources than exchange rate market it clear that a protracted sudden stop national economy, commodity prices interventions. requiring substantial real exchange and world financial conditions. Those • The persistence of the shock is rate depreciation almost inevitably that did not use the boom years to lay important in determining whether called for debt restructuring given the groundwork for countercyclical liquidity issues become solvency Argentina’s substantial liability dol- policies had much less scope for inde- problems. A short-lived crisis, such larization. However, there is reason pendent policy actions during the credit as the capital shortage experienced to believe that with international crunch. Any attempt to boost spending by Latin America in the aftermath of support, the restructuring process dramatically, for example, could erode the 1995 Mexican crisis was much could have been much more orderly. confidence in the country’s ability to less dangerous than the long capital repay its in the future. Thus, the drought that followed the Russian Perhaps the clearest lesson from the biggest lesson is that there is no substi- crisis of 1998. Early recognition of research is that countries that were able tute for taking advantage of periods of the nature of the crisis being faced to conduct countercyclical policies were external bonanza to improve macroeco- proved to be very important. able to withstand crisis better. In turn, nomic fundamentals at home. • External financial packages are the lucky ones that earned the chance This edition of IDEA looks essential when initial conditions to conduct countercyclical policies more closely at some of these policy don’t help. This explains, for exam- were those that had previously resisted responses to the crises of the 1990s ple, why Mexico recovered fairly the temptation of taking comfort in as detailed in Dealing with an Inter- quickly in the aftermath of the favorable tailwinds and had prepared national Credit Crunch in the hopes Tequila Crisis in 1994, while Argen- for a rainy day. While some basked that it may provide clues for grappling tina’s economy collapsed when the in the sun of high global growth rates with today’s financial morass.

www.iadb.org/res 5 Ideas for Development in the Americas . Jan – Apr., 2009

Brazil: A Two-Pronged Strategy for Solvency

he 2002 Brazilian sudden stop large primary fiscal surplus, inflation possible thanks to the country’s accumu- was a clear crisis of confidence targeting, and a floating exchange rate— lated international reserves. Although Tthat mixed political aspects with and that he would not default on the the exchange rate suffered enormous low liquidity in international finan- debt, the markets regained confidence depreciation during the sudden stop, cial markets. The leading presidential and the crisis was averted. exporters could not fully profit from this candidate—now President Lula—was Despite this agreement, creditors because trade credit lines had dried up. perceived to be non-market friendly and tightened their purse strings in the Therefore, the Central Bank intervened the prospect of his election sent shiv- 2001–2002 period. During this sudden to provide trade finance to exporters. ers through the investment community. stop, the resilience of the banking sector Legally, the Central Bank could not sell Capital flows fell by some US$24 bil- was achieved thanks to several factors. its foreign reserves directly to exporters. lion, around 6% of GDP, and there was a After the end of in 1994, However, an ingenious program was put large turnaround in the current account. several banks became insolvent. During in place to guarantee that at least some However, political stroking plus tar- the second half of the 1990s, two pro- of the reserves sold by the Central Bank geted economic intervention from a grams were put in place to deal with the were channeled to exporters. Banks were government that had done its financial private and local government-owned only allowed to purchase reserves if they homework allowed it to maintain sol- problematic banks. Consequently, in showed that those reserves were going vency and avoid a meltdown. In fact, the 2001–2002, there were no large banks to be used for export financing. Sup- Brazilian economy grew more than 4% with weak balance sheets that could porting the export sector helped bring over the 2001–2002 period, making it a pose systemic risk. dollars into the country and mitigated clear case of a successful response to a The second factor that explained the shortage of currency stemming from sudden stop. the resilience of the banking sector is the reduction in foreign capital inflows. Not surprisingly, at least part of that there were no large currency mis- Throughout this period, monetary the response to this largely political matches in their balance sheets. Since policy was conducted through Inflation crisis was political in nature. The fear the turbulent flotation of the real in Targeting (IT). Another important les- that Lula would stray from Brazil’s 1999, banks were aware of the risks son of the Brazilian case is that while IT sensible macroeconomic policies and involved in large depreciations and may be a useful tool for the conduct of perhaps even default on its debt had were required, by prudential regula- monetary policy during normal times, to be assuaged. Brazilian Central Bank tion, to control the exchange rate risk, during sudden stops the target becomes Governor, Arminio Fraga, negotiated a among other risks. Even so, the sudden elusive as the monetary authority loses deal between all the presidential candi- stop could have caused disruptions. control of market interest rates and the dates, foreign investors and the IMF. In a However, the public sector played an exchange rate. Twice during this period program designed to provide good incen- important role during the crisis by the Brazilian Central Bank missed its tives to the candidates, the presidential providing insurance to banks against annual inflation targets, forcing authori- wannabes agreed to sensible policies exchange rate depreciation through the ties to implement corrections along the in return for large disbursements from issuance of dollar-indexed debts or via way. Thus, IT frameworks should build the IMF. Although the entire loan was derivatives. Importantly, the Brazil- in contingent mechanisms in order to US$30 billion, only US$6 billion would ian public sector had maintained a low successfully accommodate external be disbursed in 2002. The remainder level of dollarization prior to the crisis shocks without undermining the cred- would be disbursed when the next presi- enabling it to assume the exchange rate ibility of the framework. dent was in office, provided he fulfilled risk in its own balance sheet, without Together, the Brazilian Central the IMF program conditions. After Lula compromising its own sustainability. Bank’s interventions to shore up the won the election and it became clear that A second strategy that helped banking sector and to provide credit to he would uphold the three basic tenets of tide Brazil through the credit crunch exporters helped the country weather Brazilian macroeconomic policy—the was aimed at exporters and was made the political and financial storms.

6 Jan – Apr., 2009 . Ideas for Development in the Americas

Applying the Past to the Present

atin America learned many lessons the ongoing global recession, particu- For multilaterals, the current during the 1990s that will most like- larly in rich nations. crisis offers an opportunity for a dif- Lly apply in the prevailing financial On the fiscal front, the picture is ferent approach when compared with crisis. To begin with, the availability of less clear. Most of the region’s nations the policy course taken during the counter-cyclical policy options, as well built up very little savings during the Russian crisis. The prevailing view as final outcomes, will to a large extent five-year commodity boom that ended in 1998 was that emerging nations be determined by initial conditions. last year, according to a 2008 IDB needed to reassure creditors about However, policy reactions will remain study titled “All that Glitters May Not the solvency of their economies. As a key especially in countries where ini- Be Gold: Assessing Latin America’s result, emerging countries around the tial conditions have not predetermined Recent Macroeconomic Performance.” globe were asked to tighten their belts their destiny and there is some margin A simple average of the region’s seven by cutting spending and raising interest for maneuver. The multilateral system biggest economies—Argentina, Bra- rates, which deepened the recession. can help these governments by boosting zil, Chile, Colombia, Mexico, Peru The IDB study of successful policy their foreign currency reserves and pro- and Venezuela—shows that they responses during past crises suggests viding financing for governments with spent 77% of the extra revenue from multilaterals should follow a selective a sustainable fiscal position. In other the commodity bonanza since 2002. approach that takes into account each countries, seeking external financial Chile, in comparison, which set aside country’s initial conditions in order to assistance sooner rather than later might a considerable part of the increased design tailor-made policies. Countries prove to be the least costly option. tax collection into a special fund, spent with their macroeconomic house in Latin America and the Caribbean only 34%, according to the 2008 study. order need not enact strong adjustment are in better economic shape than they Some nations in Lain America that did policies to signal credibility. However, were when the Russian crisis struck, not squirrel away enough savings will countries need to be particularly cau- giving them some leeway, particularly be forced to cut spending in the face of tious regarding the duration of the regarding monetary policy, to imple- the current crisis. For others, the most current crisis; large and/or sustained ment measures to fight the crisis. feasible policy will be to maintain the downturns in global economic trends Countries have built up US$ 400 bil- current level of government spending could make fiscal caution a necessary lion in international reserves, and they but only a lucky few such as Chile are element of any policy-response pack- have substantially reduced the level of in a position to increase spending. age. dollar-denominated debts, particularly within the banking system. Lower lev- els of debt dollarization allowed Brazil,

▼ from page 5 for example, to loosen monetary policy amid the credit crunch in ways that other countries were not able to do Peru: Where Reserves Saved the Day during the aftermath of the Russian crisis. This time around, several Latin reforms guaranteeing judicial stability ments in the tradable sector acted as a American countries swiftly depreciated and equal treatment for foreign invest- buffer for the slide in other economic their currencies without causing major ment. The privatization process took activity in 1997–99. financial turmoil. off in 1991 and investment poured in, Peru did not have all its macroeco- Loose monetary policy typically mainly in the tradable sector. Invest- nomic pieces in place when the Asian leads to currency depreciation and an ment and projects in the mining sector, crisis hit but it managed to survive the increase in exports that helps ease the for instance, propelled average growth shock well. Certainly, the credibility economic slowdown. However, curren- rates to 10.1% annually from 1993 to built earlier in the decade by a series cy depreciation, which boosted exports 1997. And they enabled the sector to of monetary and fiscal reforms paid as a way out of the crisis for several continue growing at a similar pace off. However, the life jacket that really emerging markets in the past, may be (9.9% per year) during the sudden stop kept the Peruvian economy afloat was less successful this time around given of 1998–99. Overall, previous invest- its cushion of international reserves.

www.iadb.org/res 7 Ideas for Development in the Americas . Jan – Apr., 2009

New Publications

Available in English only unless otherwise stated. Books pose for integration agreements and to explores the conditions under which propose actions for dealing with them. collapses are least or most damag- Dealing with an ing, as well as the type of shocks that International Credit make collapses more likely or severe, Research Department Crunch. and additionally quantifies the welfare Working Papers Edited by Eduardo cost associated with output collapses. Cavallo and Information, Externalities and Socio- Alejandro Izquierdo. economics of Malaria in Honduras: A Do Welfare Programs Damage Inter-American Preliminary Analysis (WP-670) Interpersonal Trust? Experimental Development Bank. María Victoria Aviles and José Cuesta Evidence from Representative 2009. Samples for Four Latin American This paper explores how different lev- As the world confronts Cities (WP-668) els of knowledge correlate with desir- an oppressive credit crunch, it is use- Alberto Chong, Hugo Ñopo and able preventive and curative practices ful to review the policy responses of Vanessa Ríos against malaria in Honduras. The countries to the systemic sudden stops paper additionally analyzes “informa- This paper argues that welfare pro- of the 1990s. Countries have experi- tion externalities” associated with non- grams are linked with the destruction mented widely, providing a rich array specific malaria health services, com- of social capital, as measured by inter- of cases that offer useful policy les- municational campaigns and organized personal trust in laboratory games. sons. This book documents success community networks. Using the 2004 The paper employs experimental data stories in Chile, Peru and Brazil, and ENSEMAH survey, the analysis finds for representative samples of individu- outlines lessons learned from unsuc- that the adoption of desirable preven- als in four Latin American capital cit- cessful cases as well. It also takes a tion and treatment behaviors correlates ies (Bogota, Lima, Montevideo, and more systematic approach in analyz- with proficient levels of knowledge. San Jose), finding that participation in ing the impact of policies for a wider While information externalities exist, welfare programs damages trust. The range of emerging markets. they nonetheless do not deliver ade- findings also support the notion that quate levels of knowledge proficiency to low take-up rates may be due to stig- ma linked with trust and social capital, INTEGRATION AND TRADE Deepening induce desirable anti-malaria behavior. Deepening Integration in Regional integration among asymmetric countries is a hot and burning policy topic worldwide. Deepening Integration in MERCOSUR analyzes Integration in rather than transaction costs. the most important issues of economic integration and policy coordina- tion that countries face as they advance towards deeper integration and are urged to address development disparities among partner coun- MERCOSUR: Dealing Output Collapses and Productivity tries. To provide a concrete angle to the investigation, the chapters Deepening Integration in MERCOSUR herein focus on the experience of the Southern Common Market (MERCOSUR). However, the lessons learned are valuable to other inte- Dealing with Disparities with Disparities. Rising Mortality and Life Expectancy gration agreements—particularly of the South-South type—such as the Destruction (WP-666) Andean Community or the Central American Common Market. The contributors to the volume are highly regarded economists from Europe and Latin America, selected for their international experience, expertise MERCOSUR Edited by Juan Blyde, Juan Blyde, Christian Daude and Differentials by Lifetime Earnings in in the field and innovative work. Eduardo Fernández- Eduardo Fernández-Arias the United States (WP-665) Arias and Paolo Julian Cristia 978-1-59782-072-1 Juan S. Blyde, Eduardo Fernández-Arias, Paolo Giordano, Editors This paper analyzes the long-run Giordano.Inter- Inter-American Development Bank relationship between output collaps- Are mortality and life expectancy dif- AmericanDevelopment es—defined as GDP falling substan- ferences by socioeconomic groups Bank. 2008. tially below trend—and total factor increasing in the United States? Using This book analyzes productivity (TFP), using a panel of a unique data set matching high-qual- the most important issues of econom- 71 countries during the period 1960- ity administrative records with survey ic integration and policy coordination 2003 to identify episodes of output col- data, this study explores trends in that countries face when they advance lapse and estimate post-collapse TFP these differentials by lifetime earn- towards deeper integration and need trends. Collapses are concentrated in ings for the 1983 to 2003 period. The to address development disparities developing countries, especially Afri- results indicate a consistent increase among partner countries. The volume can and Latin American, and were in mortality differentials across sex builds upon the experience of MER- particularly widespread in the 1980s in and age groups. The study also finds COSUR to explore the various facets Latin America. Overall, output collaps- a substantial increase in life expec- of an integrated approach, both to es are systematically associated with tancy differentials: the top-to-bottom uncover the challenges that disparities long-lasting declines in TFP. The paper Continued on page 9 ▼

­­8 Jan – Apr., 2009 . Ideas for Development in the Americas

New Publications ▼ from page 8 quintile premium increased around working in the formal sector. These have addressed market failures and 30% for men and almost doubled for results have important implications facilitated the provision of public goods women. These results complement for the design of family and child-care necessary for each activity. The case recent research pointing to almost five policies. studies additionally profile first movers decades of increasing differential mor- in each activity and describe the posi- tality in the United States. A Moving Target: Universal Access tive externalities they provide to imi- to Healthcare Services in Latin tators, particularly diffusion of export Report of Results of the LAPOP America and the Caribbean (WP-667) knowledge. Also included are coun- 2008 Surveys (Reporte de resulta- William D. Savedoff terfactual cases of a less successful dos de las encuestas LAPOP 2008) Healthcare services are more wide- firm or activity (an unsuccessful wine (WP-669) spread in Latin America and the exporter, other types of berries, and Lucas Higuera Caribbean today than 50 years ago, commodity pork production rather This document analyzes the relation- yet this availability is not necessarily than custom cuts, respectively) and a ship between political institutions and reflected in popular perceptions. This discussion of policy implications. subjects such as quality of life and study documents the expansion of victimization in light of the LAPOP healthcare services in the Region in The Emergence of New Successful (Latin American Public Opinion Proj- terms of medically-trained profession- Export Activities in Mexico: ect) surveys. The results show that als, service utilization, and insurance Three Case Studies (R-555) Latin Americans’ perceptions of their eligibility. It finds that people in coun- Edgar Aragon, Marcia Campos and life and their country vary from reality tries with more doctors have a more Anne Fouquet and that they still see democracy as positive view of access to healthcare This paper consists of three case the most desirable political system for and greater confidence in the health- studies of the emergence of three governing their countries. care system. However, other factors successful export activities in Mexico: intervene in this relationship between avocado production, the manufacture Part Time Work, Gender and Job perceptions and objective indicators, of catheters, and call center outsourc- Satisfaction: Evidence from a such as the strength of local social ing. Included is a counterfactual case Developing Country (WP-664) networks and wealth. As a conse- of a less successful activity (mangos, Florencia Lopez Boo, Lucia Madrigal quence of rising expectations, differ- stem cell banking, and other types of and Carmen Pagés-Serra ential access and continuing discon- business process outsourcing, respec- tent, public policy can be driven by tively) and a section on policy implica- This paper investigates the relation- factors that are least likely to improve tions. ship between part-time work and job the population's health. satisfaction using a recent household The Emergence of New Successful survey from Honduras. In contrast to Export Activities in Uruguay: Four previous work for developed countries, Research Network Case Studies (R-556) this paper does not find a preference Working Papers Carlos Casacuberta, for part-time work among women. Rosario Domingo, Hector Pastori, Instead, both women and men tend The Emergence of New Successful Lucia Pittaluga and Michele Snoeck to prefer fulltime work, although the Export Activities in Latin America: preference for working longer hours The Case of Chile (R-552) This paper studies the emergence of four is stronger for men. Consistent with Manuel Agosin and successful export activities in Uruguay: an interpretation of working part-time Claudio Bravo-Ortega computer software, forest products, as luxury consumption, the paper This paper surveys overall export caviar and sturgeon meat, and animal finds that partnered women with chil- growth in Chile and focuses on three vaccines. Included in each case study is dren, poor women or women working case studies of the emergence of suc- a counterfactual case of a less success- in the informal sector are more likely cessful export activities: wine, pork ful activity (electronics, wine, frog meat, to prefer full-time work than single and blueberries. Each case study dis- and biotechnology, respectively) and a women, partnered women without cusses how companies, associations, section on policy implications. Continued on page 10 children, non-poor women or women and governments at various levels ▼

www.iadb.org/res 9 Ideas for Development in the Americas . Jan – Apr., 2009

New Publications ▼ from page 9

finding is consistent with recent empiri- Foreign Participation and Hiring Outside Publications cal research on the ineffectiveness of Patterns after Privatization aid in achieving or Alberto Chong and Virgilio Galdo. Would a Free Trade Agreement promoting democratic institutions. Labour: Volume 23 Issue 1, Pages Between Bolivia and the United 195–207. March, 2009. States Prove Beneficial to Bolivian Openness to Trade and Output Critics of globalization claim that foreign Households? Volatility: a Reassessment ownership of privatized firms is linked Richard Bennett, Carlos Ludena, Eduardo Cavallo. Economía. Volume 9, to negative post-privatization labor out- Bhavani Shankar and Roberto Telleria. Number 1, Pages 105–152. Fall 2008. comes, such as more firing and less Journal of International Agricultural This paper presents new empirical evi- hiring. This paper uses new firm-level Trade and Development, Volume 5 dence that suggests that the net effect data for a cross-section of countries to Issue 1 (2009). of trade openness on output volatility test this idea and provides evidence is stabilizing. The results confirm that This paper seeks to provide insight that foreign purchasers of state-owned exposure to trade raises output vola- into whether the Bolivian economy enterprises tend to acquire firms that tility through the terms-of-trade chan- and its households would win or lose were already better restructured before nel as previously documented in the from entering into a trade liberaliza- privatization. Additionally, this paper literature, but also show that this is tion agreement with the US. The article does not find evidence that foreign par- counteracted by a quantitatively larger indicates that reaching a trade agree- ticipation in privatized firms is linked to stabilizing effect. Additional evidence ment with the US would pay off. How- negative labor outcomes. is presented showing that the latter ever, an absolute trade liberalization effect comes (at least in part) through scheme would not be the best option Volatility and Firm Growth the financial channel. for the Bolivian poor. Sector specific Alberto Chong and Mark Gradstein. measures in the form of protection for Does Openness to Trade Make Journal of Economic Growth, March, sensitive commodities would ensure Countries More Vulnerable to pp 1–25, Volume 14, Number 1. that expected benefits are more evenly External Crises, or Less? Using March, 2009. distributed across most Bolivian house- Gravity to Establish Causality. A growing body of macroeconomic holds. Negative impacts from the elimi- Eduardo Cavallo and Jeffrey Frankel. evidence suggests that volatility is nation of US trade preferences to Boliv- Journal of International Money and detrimental for economic growth. The ia and failure to sign a trade agreement Finance, Volume 27, Issue 8, Pages channel through which this material- with the US suggest that a strong pro- 1430–1452. December 2008. izes, however, is less clear. Moreover, tectionist trade policy and limited trade Openness to trade is one factor that substantive evidence based on disag- relations must be avoided if economic has been identified as determining gregate data is scarce. This paper pro- growth and household wellbeing are to whether a country is prone to sud- vides empirical support for this rela- improve. den stops in capital inflows. Several tionship using a detailed cross-coun- authors have offered empirical evi- try firm-level dataset. It also provides Can Foreign Aid Reduce Income dence that having a large tradable additional evidence that institutional Inequality and Poverty? sector reduces the contraction needed obstacles magnify the adverse effect Cecilia Calderon, Alberto Chong to adjust to a cut-off in funding. Such of perceived volatility on firm growth. and Mark Gradstein. Public Choice, studies may, however, be subject to February 2009. the problem that trade is endogenous. Television and Divorce: This paper’s goal is to examine the Using the gravity instrument for trade Evidence from Brazilian Novelas effect of foreign aid on income inequal- openness, which is constructed from Alberto Chong and Eliana La Ferrara. ity and poverty reduction for the period geographical determinants of bilateral Journal of the European Economic 1971–2002. The paper finds some weak trade, this paper finds that openness Association, Papers and Proceedings. evidence that foreign aid improves the indeed makes countries less vulner- April, 2009. (Also published as WP-651) distribution of income when the qual- able to crises, and that the relation- This paper studies the link between ity of institutions is taken into account; ship is even stronger when correcting television and divorce in Brazil by however, this result is not robust. This for the endogeneity of trade. Continued on page 12 ▼

10 Jan – Apr., 2009 . Ideas for Development in the Americas

Look Who’s Talking

This section of the newsletter spotlights presentations or events sponsored by RES in recent months.

Klaus Schmidt-Hebbel term growth policies are likely to aid “off-the-shelf” projects (i.e., those that presented the OECD’s recovery from the current financial are, in U.S. parlance, “shovel-ready”). crisis. While the crisis represents a The research underlying this recom- flagship publication, failure of regulatory and supervisory mendation cites the high short- and Going for Growth 2009, policies, it does not invalidate the need long-term multiplier effects of public in a policy seminar at for reforms to improve labor and prod- investment on GDP. Appropriate tax uct market performance; moreover, cuts depend largely on each country’s IDB headquarters on the likelihood of structural reforms existing tax structure, but available March 5, 2009. increases in periods of crisis. In the evidence offers a rank ordering of the short term, policies should stimulate long-term growth effects of various The fifth edition of Going for Growth, short-run demand and strengthen types of taxes. Corporate taxes have the flagship publication of the Organi- long-term growth. OECD analysis sug- the most deleterious growth effects, sation for Economic Co-operation and gests policy mixes drawn from the fol- followed by labor income taxes, taxes Development (OECD), is like its pre- lowing options: i) enhanced infrastruc- on goods and services, and taxes on decessors based on a benchmarking ture investment; ii) tax cuts for lower immovable property. and analytical process that identifies income groups; iii) increasing human Of particular long-term impor- five policy priorities for each member capital through labor training; and iv) tance is the strengthening of edu- country in order to enhance long-run reforming product market regulation, cation and training, which largely economic growth. The report’s meth- particularly through removing obsta- determine productivity and growth. odology consists of decomposing GDP cles to starting up businesses. Any fis- As experience from previous down- per capita, the best available proxy for cal stimulus that is implemented must turns has shown that extensive use of welfare, into labor utilization (hours nonetheless be timely, temporary and early retirement decreases productiv- worked) and labor productivity fac- targeted, and its size must be deter- ity, policy responses such as manda- tors. Although both areas are affected mined by overall economic conditions, tory training programs for the unem- by policy, productivity is considerably initial fiscal balance and debt levels, ployed are likely to facilitate transition more important and is therefore the and the size of the automatic stabiliz- to new , as well as stimu- focus of most of the 50 policy indica- ers in effect. The targeting of such a late aggregate demand. In the United tors used in the analysis. On the basis package must additionally strive for States, an extension of unemployment of these indicators, the benchmarking short-term stabilization, long-term insurance payments is advisable, as methodology proceeds in three steps: growth, and job creation, as well as is aid conditioned on participation in i) identifying performance weakness- include a “green” component to make training programs. es, defined as deviations from the future economic activity more environ- A final important area for reform is OECD average, in subcomponents of mentally sustainable. product market regulation, especially GDP per capita; ii) identifying related The long-term recommendations the reduction of obstacles to trade, for- policy weaknesses on the basis of in the 2009 edition of Going for Growth eign direct investment, and firm entry. policy indicators and analysis; and iii) are in part based on new empirical Strengthening competition in product selecting the most important policy findings. Although the current finan- markets is expected to increase long- weaknesses as priorities for reform. cial crisis provides an opportunity term productivity by improving the The third step results in five recom- to reverse an OECD-wide decline in utilization of resources and spurring mendations for each OECD member infrastructure investment, such invest- entrepreneurship, promote the entry country, three based on benchmarking ment must be undertaken in a sound of new firms, and may also help to alone and the remaining two based regulatory environment and with care- raise demand in the short term. Stud- on the country-specific expertise of ful cost-benefit analysis of projects. ies conducted by the OECD addition- OECD researchers. Fiscal stimulus based on infrastruc- ally indicate that strengthening product In contrast to previous editions ture can begin prior to the implemen- market competition accelerates the of Going for Growth, however, the tation of those projects through main- convergence of country growth rates 2009 report discusses which long- tenance expenditure and beginning with the OECD average.

www.iadb.org/res 11 Ideas for Development in the Americas . Jan – Apr., 2009

New Publications ▼ from page 10

exploiting variation in the timing of avail- Fabio Ghironi, Talan Iscan and oil demand and supply shocks on the ability of the signal of Rede Globo—the Alessandro Rebucci. Journal of merchandise trade balance and the network that had a virtual monopoly International Money and Finance. 27, current account depends critically on on telenovelas in the country—across pages 1337–1359. 2008. the response of the non-oil trade bal- municipal areas. Using three rounds of This paper finds that permanent ance. The results provide evidence Census data (1970, 1980 and 1991), it worldwide productivity shocks lead of an intermediate degree of interna- finds that the share of women who are to net foreign asset and consumption tional financial integration. Also, the separated or divorced increases signifi- dynamics that are broadly consistent paper documents the presence of cantly after the Globo signal becomes with interpreting the U.S. as the rela- large and systematic valuation effects available. The effect is robust to con- tively impatient model economy and in response to these shocks. Valua- trolling for potential determinants of are not consistent with symmetric tion effects overall tend to cushion Globo’s entry strategy and is stronger models with equal discount factors. the effect of oil demand and supply for relatively smaller areas, where the shocks on the NFA positions of oil signal reaches a higher fraction of the Oil Shocks and External Balances. exporters and oil importers. Finally, population. Lutz Killan, Alessandro Rebucci it quantifies the overall importance of and Nikola Spatafora. Journal of global demand shocks Net Foreign Asset Positions and International Economics. 77, pages as well as oil-market specific demand Consumption Dynamics in the 181–194. 2009. and supply shocks for external bal- International Economy. This paper shows that the effect of ances.

Students in metropolitan Colombia. GRADE, Peru Network News • Evaluating the Effectiveness of Radio Programs as a means for Finan- cial Education among Low-Income Latin American and Caribbean Research Network Households in Cuzco. GRADE, Peru The following proposals were selected to participate in the research project: Infor- • Can ICTs Prevent Malaria? Evidence mation and Communication Technologies (ICTs) and Societal Empowerment from a Randomized Experiment in the in Latin America and the Caribbean Border Between Ecuador and Peru. SASE, Perú • ICTs and Student Absenteeism in • Empowering Internally Displaced • ICTs, Job-Search, and Informality: A Argentina. MBC Consultores Mori People in Colombia through the use of Randomized Social experiment for • A Study of the Mechanisms that affect ICTs. Universidad del Rosario. Disadvantaged Youth in Peru.¨ SASE, Student Absenteeism in Argentina. • ICTs and Small and Medium Enter- Perú Results from a Field Experiment. MBC prises’ (SMEs) Performance in Costa • The impact of ICT in health promo- Consultores Mori Rica: A Randomized Controlled tion: a randomized experiment with • Impacts of ICTs on Productivity Experiment. Fundación CAATEC. Diabetes patients. Universidad Ort, and Corruption in the Allocation of • ICTs and Student’s Achievement: Evi- Uruguay National Identity Cards within the dence from a Randomized Experiment • A randomized experiment to evaluate Bolivian Police. Grupo de Investigación in Ecuador. Stratega BDS. the impact of ICT in health prevention Almuray • Modern ICTs Can Empower Honduran in adolescents. Universidad Ort, Uru- • Investing in learning at secondary Farmers by Providing Access to Current guay schools in Chile. Universidad de Chile Market Price Information. Alpresa S.A. • Benefits of Information in Colombia’s • Evaluating the Effectiveness of Online The research proposals are available on agricultural markets. CEDE, Universi- Sexual Health Education for Risk our web site: www.iadb.org/res/network dad de los Andes Reduction among Public School www.iadb.org/res/researchnetwork 12