5:42 PM Sep 6, 1995


Geneva 11 Sep (Chakravarthi Raghavan) -- The UN Conference on Trade and Development which, through its annual Trade and Development Reports, has been a pace-setter in challenging conventional wisdom and orthodox economic policies, has again reiterated the call for rethinking economic policies to promote accelerated growth and development in the South and in the North.

The TDR has again called upon Latin American countries, and the international institutions, to rethink development and economic strategies and learn from the experiences and successful strategies in the Far East and South and South-East Asia.

In past reports, the TDR has challenged the view of the World Bank and the orthodox school about the ingredients of the Asian success, and has underlined the critical role played by the State in Asia in mobilizing savings and capitals, directing investments and fostering technological innovation and increasing competitiveness, faster growth and development and accomplishing these with rising real wages and earnings of labor.

As in the past, the TDR has also come out against premature and wholesale liberalization of external sectors, and particularly of the financial sectors, and advocated controls on short-term capital flows to be made a permanent feature of the financial system.

After long opposing this, the IMF recently has come around to usefulness of short-term capital controls.

In focusing on developments in the Latin American over the past year, the TDR notes that the main reversal for slow down in Latin America is the reversal of capital flows and the after effects of the Mexican peso crisis.

While the external financial turbulence in Latin America took most observers and market participants by surprise, the TDR notes that it has been repeatedly warning that the surge of capital flows to Latin America would peter out.

The bursting of the bubble, the TDR adds, could have been prevented through capital controls which are consistent with the IMF's Articles of Agreement and practised by a number of highly market- oriented Latin American countries.

Carlos Forti, the Officer-in-charge of UNCTAD, at a news briefing made a pointed reference to these, and noted that just recently in a new report, the IMF (which had been resisting such ideas and had openly criticised UNCTAD for its views in the TDR) was now seeing merit in capital controls against short-term flows as practiced in Chile and Malaysia.

Yilman Akyuz, another senior economist heading the UNCTAD's macroeconomic unit, said that while it is easier to control inflows than outflows, controls on outflows too are useful. Akyuz cited in this connection the views of the Central Bank Governor of Colombia (where capital controls are used) to the effect that while the accepted theory is that all capital controls are useless, since they become, quite quickly, ineffective, "this is only a half-truth". "One could argue, Miguel Urrutia Montoya told a G-24 organized conference at Cartegena in April 1994, "that a large portion of capital flows can be controlled. In that case rules and regulations could be helpful."

Regulations, the Colombian official has said, are ineffective in keeping nationals from exporting capital when they lose confidence in their local currencies. It can also be extremely difficult to avoid capital repatriation by nationals.

"Nevertheless, it is clearly possible to avoid market failures that involve destabilizing flows from regulated financial institutions. These are the agents that can make the largest short-term capital transfers. In this case controls are effective."

The TDR also has questioned the current views and explanations from the IFIs and others that the Mexican failure was due to policy slippage and lack of transparency and information.

"The external financial imbalances emerged in Mexico, because that country succeeded all too well in following orthodox prescription for financial liberalization and adopted an easy, popular policy of relying on capital inflows for disinflation, using the nominal exchange as an anchor. Blind faith in these policies explains why there was so much complacency and inaction in Latin America and the international financial community throughout the 1990s when exchange rates were appreciating in real terms and trade and current account deficits were growing rapidly..."

The way the Mexican crisis evolved is in sharp contrast to the orthodox view that BOP crisis occur only as a result of fiscal imbalances. This was not the first time either when a crisis has taken place in Latin America despite fiscal equilibrium, the TDR said noting the problems of Chile in late 1970s and early 1980s, despite its budget surplus and liberal trade and financial policies.

And instead of assessing the costs and benefits of financial openness, the TDR complains, there was once again a tendency to seek "post hoc ergo propter hoc" explanations.

On the blame now put for the crisis in the lack of transparency in macroeconomic policy, particularly state finances and pace of monetary expansion, the TDR again caustically notes that it was not clear how greater transparency would have avoided outbreak of the crisis. It notes that since early 1990s, capital kept on flowing into countries, such as Brazil, with much larger macroeconomic imbalances than Mexico.

"The mounting external deficits in Mexico were not due to expansionary macroeconomic policy but, rather, to premature and rapid trade and financial liberalization and use of exchange rate for quick disinflation which, via reduced tariffs and appreciation, resulted in a surge of cheap imports ahead of establishment of a sound export base... the crisis occurred because of the 'excessively rapid' opening of the economy to external competition; the equally 'excessive' reliance on short-term, speculative capital; the 'excessive' overvaluation of the peso; and electoral considerations that led to the avoidance of opportune decisions."

Asked about the cautionary advice to developing countries against premature and excessive financial liberalization and need to maintain some capital controls and the situation of developing countries within the WTO under GATS and the new interim financial services accord, Andrew Cornford, a senior economist specializing in banking and other financial services, said that the GATS itself enabled developing countries to undertake liberalization at their own pace. While the United States, he noted, was pressing the developing countries to open up fully and liberalize their financial markets, the interim accord (with the US not a party) had taken a more modest approach.

He agreed that commitments entered into in the WTO -- for opening domestic financial markets to foreign pension funds and security firms and portfolio investments -- would restrict the ability of countries to use capital controls. The interim accord in any event would run only till end of next year, and developing countries would have all their options open, he added.

Cornford had been asked about the reported views of the EU (which was behind the interim accord) that it would be rolled over with constant ratcheting up of the concessions from the South. Cornford's response seemed to imply that before the WTO financial services interim accord ends, the developing nations could review the entire issue -- in the light of the Mexican crisis, the IMF's own new thinking on capital controls and UNCTAD's overall non-orthodox views and advises on this.

In looking at the prospects in Latin America, the TDR questions the official view in Mexico and abroad that the crisis is "virtually over". It notes current projections are for a 5% fall in output in 1995. While the manufacturing sector was working only to 40% capacity, inflation could be expected to be as high as 70 percent. And while export growth has been quite strong, much of it is in highly import-intensive assembly plants with little backward linkages to the rest of the economy. Increased exports are associated with falling industrial production and imports have fallen little despite sharp contraction of economic activity and devaluation of the peso.

These coupled with the slowdown in the US, would mean that the planned reduction in current account deficit -- from $35 billion to $2 billion -- could not be achieved without large import cuts. With the large stock of dollar and dollar denominated debt of households and financial and non-financial corporations compounding the deflationary consequences of the peso devaluation, Mexico could be facing a debt-deflation-cum-recession process as serious as that of the US and Japan in the late 1980s and early 1990s. The already strong contractionary influences, coupled with the tight monetary and fiscal policies in place might well result in a deflationary over-kill, UNCTAD warns.

"The more the government succeeds in stabilizing the peso and gaining the financial market's confidence, the more will be opportunities for short-term profits.... a band-wagon may emerge once more, unless controls are introduced to limit capital flows."

In Argentina, under current policies the main question is how much unemployment would be needed to improve competitiveness-- given the government's exclusion of the most potent instrument for that, namely, exchange rate -- and whether such a level of unemployment would be politically acceptable.

With its fixed exchange rate, Argentina faces a number of policy dilemmas. Given the importance of this trade with Brazil, a continued appreciation of the real would be most helpful. But this is not a viable option for Brazil. Hence the only way for Argentina to restore export competitiveness is through a fall in nominal wages and prices of non-tradeables or investment-led rise in productivity. A significant nominal deflation of prices and wages is implausible and would, in any case, cause serious financial difficulties for firms and banks. Without an improvement in real exchange rates and fall in interest rates from the current over 20%, there is little prospect of increased investment in tradeables.

The burden of adjustment would hence have to fall on imports. A generalized increase in tariffs is not feasible, and would also go right against the government's free-market philosophy. Hence import cuts would have to be effected by reducing domestic demand, setting off recession. Though external financial support is now much greater, adjustment could be as painful as the 1980s.

The new conditions in international financial markets caught the Brazilian economy in a particularly vulnerable situation -- with the external accounts becoming unsustainable in the first months of the new administration even as the stabilization plans (the real plan) was still in early phase.

But the government brought greater realism to policy-making before it was too late. While there are many difficulties, Brazil has greater scope than other major countries of the region to use trade measures to deal with its external and domestic imbalances. Since its economy is not dollarized, devaluations would not have the same financial implications as in Mexico and Argentina. There is also considerable scope for privatization to reduce government deficits and debt -- the Achilles heel of its stabilization programme. But

Latin American countries, the TDR says, need to overcome the constraints on development and growth by raising domestic savings rapidly and directing investment to traded goods. But the current policies of governments in the region would not be able to achieve these.

The policy reforms adopted in response to the crisis of the 1980s need to be reviewed, and changed, with focus on finance, trade and the public sector, the TDR says.

Drawing from the lessons and experiences of Asia, the TDR notes that though profits have been as high in Latin America, the propensity to reinvest has not been strong. This was because of the opportunities provided in Latin America to earn high rents from unproductive channels.

Liberalization and deregulation may have closed some old channels, but have opened new ones, particularly in the sphere of finance, opening opportunities for new rentier incomes.

UNCTAD also argues that while a considerable degree of trade liberalization was called for in Latin America to accelerate industrialization, the pendulum had swung too far.

The average and maximum tariff rates were considerably lower, and their dispersion smaller, in the successful East Asian economies with more solid industrial bases.

"In all successful examples of modern industrialization, import liberalization followed, rather than preceded, export success... this sequence would necessitate breaking through the limits of static comparative advantage based on abundant unskilled labor and/or natural resources and promoting industrialization based on establishing comparative advantage.

"It is thus necessary to reconsider trade policy in Latin America, within the bounds of international commitments already made, and seek trade-equivalent fiscal measures to help promote rapid industrialization based on exploitation of dynamic comparative advantage in high-technology, high-skill industries."

Citing a recent World Bank report on Latin America (after the Mexican crisis) the TDR says that in fact there was no disagreement over the key variables for accelerating growth and industrialization in Latin America.

"What is at issue is the policies which will improve performance under these headings. In this respect, a rethinking of economic policy appears to be called for."