8:16 AM Apr 16, 1997

LATIN AMERICA: LIBERALIZATION & STABILIZATION EQUALS UNEMPLOYMENT

Geneva, 14 Apr (Chakravarthi Raghavan) -- The experiences of Argentina, Brazil and Mexico -- since they adopted the neo-liberal economic policies -- suggests a stringent trade-off between stabilization and sustainable external accounts, and the price for having both at the same time appears to be reduced rate of growth, with inevitable welfare prospects for the poor.

As a result of policies of trade liberalization and efforts to ensure sustainable external accounts, these countries have been forced to pay the price of reduced rates of growth, resulting in falling industrial employment, rising unemployment and informal employment, and regressive movement of relative wages and negative effects on welfare prospects for the poor, according to Brazilian economist Edward J Amadeo in a paper published in the UNCTAD Review 1996.

"The long term prospects (for these economies) are still uncertain says Amadeo, who is at the department of economics of the Catholic University of Rio de Janeiro, in Brazil.

Amadeo's paper looks at macro-economic and labour market performances of the three major economies of Latin America, the macro-economic consequences of their trade and financial liberalization coupled with exchange-rate stabilization, and the responses of industrial employment, unemployment, real wages and relative wages.

The analysis, Amadeo says, shows the negative impact on industrial employment of over-exposing these economies to external competition can be very significant and that, contrary to what is expected, effects on distribution of income, as far as wage-differentials are concerned, can be negative.

In the three countries, Amadeo notes, the combination of trade liberalization and exchange-rate-based stabilization has imposed considerable adjustment pressure. The process of adjusting to change in the competitive environment - if successful in bringing about stabilization and growth - may not only be long but also imply output losses.

It is well-established in economic literature that trade liberalization should not be followed by currency appreciation. And the extent to which increase in imports and external imbalances is sustainable depends on the speed with which domestic inflation converges with international rate of inflation. Any real exchange rate appreciation and change in relative prices against import and export competing sectors may lead to strong imbalances.

In a pessimistic view, the external imbalances in Latin American countries would be seen as result of the drastic trade liberalization and lack of investment in the tradeable goods sector, and real appreciation of the domestic currency, would be yet another element in creating external imbalances.

Analysts usually look at results of the Chilean experience in assessing reforms and stabilizations in Latin American economies over the past few years, he notes.

Chile has become the "sole star performer" on the continent in the 1990s, while Argentina, Brazil and Mexico, though making important progress are still seen as "transitory".

In Chile in the 70s and 80s, and other Latin American countries since late 1980s, the reform policies are similar: trade and financial liberalization, reform of the State and deregulation of capital and labour markets.

In Chile, the macro-economic performance in the 1990s is impressive, but the transition was very long and difficult.

"Even more important," Amadeo notes, "the levels of GDP, per capita manufacturing output and real wages in 1989 (just before the 1990s take-off) show that 20 years of reforms did not add much to welfare and wealth of country. The GDP grew by 17.4% between 1970 and 1989 or an annual 0.78%, per capita manufacturing output fell by 9% and real wages by 8%, while over the adjustment period rate of unemployment reached a peak of 31.3% in 1983.

Studies of the Chilean experience show several striking similarities to the current reform and stabilization efforts of Argentina, Brazil and Mexico.

The exchange rate policy in Chile was at odds with trade policy and as a result the value of the local currency rose steeply in real terms. The liberalization of external financial accounts and capital inflows helped to support the appreciation of the exchange rate.

The trade liberalization and exchange rate appreciation require high investment ratios to engender sectoral adjustment. But if the investment is low and current account deficits start growing, a recessionary adjustment may be required.

During the first phase of Chilean reforms (1974-1981), adjustment implied reduction in value added of manufactures and disappearance of small and medium-sized passages.

In looking Argentina, Brazil and Mexico (where the reform experience differed in timing and details), Amadeo notes that Argentina has had a fixed exchange rate, while Mexico and Brazil opted for a more flexible system providing some scope for devaluations.

But there were also many common traits in the three experiences: a significant reduction of tariff and on-tariff trade barriers along with explicit use of exchange rate as a coordinating instrument for stabilization. Capital inflows and mounting reserves played an important role in supporting the exchange rate - despite growing trade and current account deficits.

As a result of trade liberalization and exchange rate appreciation, between 1991 and 1994, imports grew by 17% in Mexico, by 55.6% in Argentina and 12.3% in Brazil. But in 1995, one year after the Real Plan, imports grew in Brazil by 51 percent.

Exports grew over 1991-1994 by an annual 6.4% in Mexico, 5.5% in Argentina and 8.8% in Brazil. As a result, trade deficits grew between 1988 and 1994 from 8.8 to 58.2 percent in Mexico, from 14 to 54.2 percent in Argentina and from -11.6 to 3 percent in Brazil.

In all three cases, the rate of growth of industrial output was higher in the early phase of the process - around 6%. The real exchange rate appreciated continuously: around 50% between 1990 and 1995 in Argentina, around 25% between 1989 and 1994 in Mexico and around 25% between the first and third quarters of 1994 in Brazil (Real Plan was put into place in mid-1994).

Industrial output remained positive in Argentina (annual average of 5.4% over 1989-1994), Mexico (annual average 5.2% over 1989-1994) and for the first year of the Real Plan (mid-1994 and mid-1995) in Brazil.

But over the respective periods, trade deficits grew, leading to growing current account deficits.

Brazil though reacted to the appearance of trade and larger current account deficits much sooner than did Argentina and Mexico.

But what is common to the three countries is the required adjustment of the level of activity and rate of economic growth in order to sustain exchange rate policy and stabilization (in Argentina and Brazil) and to cope with the severe external constraints of the crisis (in Mexico).

What are the requirements for resumption of economic growth without threat of major external imbalances?

As shown by the Mexican crisis, sustainability of exchange-rate-based stabilization programmes is crucial.

"Keeping the economy on the knife-edge between current account deficits and economic growth in order to sustain the exchange rate requires enormous technical and political effort on the part of policy makers and politicians," says Amadeo.

The Mexican economy was not able to stay on the knife-edge.

Argentina is now a stable economy, but the price for the good record is a severe drop in rate of growth and level of activity. But given the reduction in industrial employment and severe increase in unemployment over the past few years, prospects of low or even negative growth rates are obviously not very good.

In Brazil, the situations seems more comfortable than in Argentina (as a result of timely adjustment in level of activity and devaluation of exchange rate applied in 1995), with both trade and current accounts having shown signs of improvement. But the level of industrial activity by end 1995 has fallen to levels at end of 1993. The prospects for economic growth in the following two years have not been very good, given the improvement in external accounts was due to reduction in level of activity.

The reduction in tariff and non-tariff protection, along with appreciation of the exchange rate, has exposed these economies to greater competition. But given the past role of import-substitution in industrialization process, this has had a significant impact on level of domestic production and employment.

Competition and access to cheaper, imported intermediary and capital goods, have had a positive effect on labour productivity, efficiency and competitiveness and this is rightly seen as an important element in increasing competitiveness of the economies.

Provided such increased productivity is matched by increased output, the net effect on employment is null by definition. There may be sectoral dislocations, but in the long run the level of aggregate employment should not change.

Measured by total industrial output to employment, level of productivity has increased dramatically in Argentina, Brazil and Mexico since 1980s -- with an annual average rate of increase of around 6-7 percent in all three countries.

However, says Amadeo, there are reasons to believe that the increase has been over-estimated. Subcontracting outside the industrial sector and increase in imports of intermediates, parts and components, tend to reduce the ratio of value added to total industrial production. When this is the case, increase in productivity measured by ratio of value added to industrial employment is smaller than ratio of total output to employment.

Using these measures, Amadeo notes, that since the early 1990s the trends in industrial employment in Argentina, Brazil and Mexico has been negative, while growth rates of unemployment has been growing, and the share of informal labour growing with rate of unemployment.

Amadeo finds little evidence for the argument of the three governments that the reduction in industrial unemployment is due to technological innovation and hence nothing can be done to revere the trend.

Has wage rigidity affected competitiveness of the industrial sector in the three countries, and hence their trade balances and industrial employment records?

Amadeo finds little evidence for this either.

In Argentina, he notes, industrial employment fell by 8% between 1990 and 1994, but real wages in the industrial sector increased. And while not really significant when compared to Brazil and Mexico, there had been no decrease in wages.

"Real wages in the industrial sectors in Argentina, Brazil and Mexico," he says, "have been growing since 1990, despite reduction in protection and industrial employment.

And while real wages grew, the increase has been roughly compensated by increase in labour productivity.

"Particularly in Argentina and Mexico, the main cause for loss of competitiveness is not 'rigidity of the real wage', but the change in relative prices between the consumer price index and industrial wholesale price index, together with increase in ratio of industrial prices to the exchange rate."

Examining the effects of trade liberalization on real wages in industry and relative wages, Amadeo notes that according to conventional view and trade theories, the net effect of trade liberalization should favour less skilled workers, both economy-wide and in the industrial sector.

But real wages increased in Argentina, Brazil and Mexico during the years of trade liberalization and exchange rate appreciation. And available evidence indicates an increase, not a decrease, in the wage differentials between skilled and unskilled workers. The data do not indicate a reduction in relative wage of skilled (or educated) and unskilled (or less educated) workers in Argentina, Chile and Mexico following trade liberalization.

In thus examining the long and difficult path to stability and growth resumption in Argentina, Brazil and Mexico, says Amadeo, it seems there is a stringent trade-off between stabilization and sustainable economic accounts. Reducing the rate of growth seems to be the price to pay for having both at the same time.

It could be argued that a low level of economic growth is a reasonable price to pay for stability in Latin American countries. After all, the three countries are relatively rich economies, where the main problem lies in unequal distribution of income. Thus a reduction in inflation has a positive effect on distribution, and reduction in growth is a worthwhile price to pay.

But the response of labour-market variables to macroeconomic and trade policies has not been very encouraging. Industrial employment has been falling, rates of unemployment and informal employment have been rising, and relative wages have moved in favour of more educated, with negative distributive implications.

The combination of low growth rates, falling employment opportunities and regressive movements in relative wages have negative effects on welfare prospects for the poor. But there may be countervailing effects: access to credit (which did not exist during periods of high inflation) and reduction in prices of tradeable goods due to opening up of the economy, increase the purchasing power of the poor.

But in the long run, prospects for labour market variables and distribution depend on eventual resumption of growth and nob creation, as well as on structural effects of technological innovations and sectoral structure of output resulting from greater international integration.

"Higher rates of growth," Amadeo comments, "would certainly create more jobs, but reduction in value added per unit of output resulting from loss of competitiveness of some sectors, together with labour-saving characteristics of new technologies have the opposite effect.

"Hence the long-term prospects are still uncertain."