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222 Cards in this Set
- Front
- Back
Shift after WWI from export-led growth to an import substitution industrialization (ISI) strategy
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Dependency Theory (In terms of)
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The obsticle to Latin American economic development was the unequal relations with foreign powers in terms of exchange.
High tarriffs Manufacturing sector completely protected Developed a very inefficient manufacturing high costs and produced low quality products |
Dependency Theory (Def)
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By 1970's 2 big oil shocks
1st oil shock |
Countries are forced to borrow to keep economies afloat
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By 1970's 2 big oil shocks
2nd oil shock |
Begins an increase in interest rates so countries cannot afford to service debt to take out new loans
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By the beginning of the 1980's capital flows to Latin America dries up...
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- Debt crisis of the 1980's
- 1980's last decade of Latin America |
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________ on greater committemnt and implementation of polices that would reduce government and liberalize markets
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Conditional Assistance
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Conditional Assistance..
(2) stages Stage 1 - Macroeconomic Adjustment |
- Control Deficit
- Decreased spending - Control inflation |
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Conditional Assistance..
(2) stages Stage 2 - Structual Reforms |
a) Liberalize Trade
b) Deregulation of labor markets c) Deregulation of credit markets d) Privitization e) Reforming the tax system |
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Reduce tarrifs and non-tarrif barriers
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Liberlize Trade
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Elimination of interest rate ceilings subsidies on loans for certain sectors reduction of reserves allowing (FDI) to come in, in the banking sector
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Deregulation of credit markets
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Reduce taxes on the hiring and dismissal of workers
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Deregulation of labor markets
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Privitizing state owned enterprises
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Privitizations
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Reduce distortions in the tax system
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Reforming the tax system
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First half of the 1990's things look rosy, but Mexico (Tequila) Crisis dries...
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priviate capital out of all the region
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Late 1990's is marked by biggest recession in decades partly driven by the fact that there is more room to...
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adjust and more competion
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Coined 1850's by a Columbian and referred to a group of countries with common geography and language
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Latin America
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Independant countries in the western Hemisphere and South of the Rio Grande
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Geography
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Countries where primary language derived from Latin, Spanish, Portugese and French.
Institutions and Colonial origins (Roman law, Portugese & spanish colonies) |
Language
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- Argentina
- Bolivia - Brazil (Portugese) - Chile - Columbia - Ecuador - Paraguay - Peru - Uruguay - Venuzuela - Mexico Cuba Dominican Republic Haiti -French |
20 countries;
10 South American Republics |
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6 Republics of Central America
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- Costa Rica
- El Salvador - Guatamala - Honduras - Nicaragua - Panama |
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Most countries gained independance in the 1820's
- Haiti gained independance in |
1804
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Most countries gained independance in the 1820's
- Domominican Republic gained independance from Haiti in |
1844
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Most countries gained independance in the 1820's
- Cuba gained independance from Spain in |
1898
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Most countries gained independance in the 1820's
- Panama gained independance from Columbia in |
1903
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At the time of independance standards of living were low but were relative to the US and Canada...
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at the time
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Latin Population was about 25 million...
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prominentaly rural
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Mining and Agriculture integrated the area with the rest of the world
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Production of Natural Resources
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Climate, geography, geology had effects on what each...
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country produced
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Integration of Latin American countries in to the world took place through exports of primary...
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products
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Differences amoung countries in terms of...
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Commodity Specialization
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Some commodities lend themselves naturally to foward linkages...
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Stimulates other sectors in the economy.
- Cattle - Meat - Leather |
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Some other commodites lend themselves to backward linkages...
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Needs inputs from other sectors.
* Copper- Mining tools and machinery |
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- Argentina - Cattle
- Honduras- Bananas - Peru - Guano (Used for fertilizer) |
Argentina; one of the 12th richest countries in the world until 1940.
Honduras and Peru; Did not benefit much |
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Commodities that easily substitutable are...
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Not good specialization
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Normal Goods
Luxury Goods |
- Worse
- Export to rich countries (Better) |
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2 World Wars and Great Depression generated disruptions in terms of imports that Latin America received from the rest of the worls
- Turned policy from... |
Export- led growth to an (ISI) Import Substitution Industrialization growth strategy
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Which Posed that the main obsticle to economic development were unequal realtions with foreign powers
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Birth of Dependency Theory
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Industrial industry was inefficient, subsidized...
Took over agriculture in terms of GDP |
by government
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is the process of meeting the basic human needs of the populaiton and enhancing options for the allocation of economic resources both today and tommorrow
(i) Indicator that measures the distribution of well being (ii) Indicator should not only capture short-run but long-run (iii) Indicator of access to basic human needs |
Economic Development
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_____ measurures the net output produced by factors of production, irrespective of whether they are national or foreign GNP adjusts for net factor income paid abroad
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GDP or GNP Per Capita
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_____ is defined as the minimum income needed to purchases socially determined essentials (i,e) food, shelter, health care, education)
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The Poverty Line
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_____ ratio estimates the percentage of people falling below the poverty line
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The Headcount Ratio
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__________ measures the size of the income or shortfall or the amount of money it would take to raise a person out of poverty
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The Poverty Gap
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________ is a weighted composite of deprivation and focuses on the following dimensions
(i) vulneralbility to death at an early age (ii) Exclusion from communicaitons (literacy rates) (iii) A decsent standard of living a) % of individuals with access to health services b) % of populaiton with access to safe water c) % of children under the age of 5 who are malnurished |
The HPI (Human Poverty Index)
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______ is a weighted composite of deprivation measured by
(i) Life expectancy at birth (ii) Educational attainment (literacy rate) in adult population and school attendance (iii) Income (average income) |
The HDI (Human Development Index)
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_________ Concentrates not only on economic participation but also on political and professional participation by including variables:
1) % of women in professional and managerial jobs 2) % of women sitting in public office |
The GEI (Gender Employment Index)
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________ measures the differnce between a hypothetical situation and complete inequaltiy and the actual distribution of income in an economy
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The Gini Coefficient (GINI= A/A+B)
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______ Economic progress measured by per capita income, accompanied by rising inequaltiy but these disparities go away as benefits of development permeate more widely
Evidence: 1) Looking at data across countries does show an inverted U-shap but driven by the Latin American countries are middle income and high inequaltiy (many other factors may be behind high inequality in Latin America 2) When looking at the experience of individual countries through time this inverted U-shaped relationship between Gini and GDP/Capita does NOT HOLD 3) Inequality & Income Growth: The hyposthesized relation is a negative relation between inequaltiy and growth a) Lack of collateral - When ther is more inequality and poverty, a large part of the population cannot afford investments into education and health b) Political Instablity/Redistribution - People care about income level but also about relative standing in terms of income-generates feeling of resentment and may drive political instability or calls for redistrbution - Political Instability: Capital leaves the countries (capital flight) and educated people leave (brain drain). Income growth falls. - Calls for Redistribution: Ususally re-distribution is done on the basis of wealth increases and not actual wealth (b/c of tax evasion) but this essentially taxes savings and capital accumualtion → Income growth falls. c) Changes in demand for goods - Lower level of demand for goods- the poor are able to buy less and lower demand means less production → Income growth falls Composition of Demand - As there are more poor people there is moore demand for basic necessities, and as there are rich people there is more rich people there is more demand for luxury goods. Basic necessaities are produced unskilled labor and reduce demand for skilled labor and machinery → economic growth. Evidence: Solid Evidence across countries and over time showing negative relation between inequaltity and growth. |
Kuznets Hypothesis
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The hypothesized relation is a negative relation between inequaltiy and growth
a) Lack of collateral b) Political instablity/redistribution c) Changes in demand for goods |
Inequality and Income Growth
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When there is more inequality and poverty, a large part of the population cannot afford investments into education and health.
And cannot borrow against investments in eduacaiton and health because there is nothing to back these loans(i.e., no collateral) |
Lack of collateral
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People care about income level but also about relative standing in terms of income-generates feeling of resentment and may drive politcial instablity or calls for re-distribution
(i) Political Instablity (ii) Calls for redistribution |
Political Instability and Redistribution
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Capital leaves the countries (capital flight) and educated people leave (brain drain)
- Income Growth Falls |
Political Instablity
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Usually redistribution is done on the basis of wealth increases and not actual wealth (because of tax evasion) but this essentially taxes savings and capital accumualtion → Income growth falls
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Calls for Redistribution
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Lower level of demand for goods - the poor are able to buy less and lower demand means less production → Income Growth Falls
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Changes in Demand
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As there are more poor people more demand for basic necessaties, and as there are richer people there is more demand for luxury goods
→ Basi Necessaties are produced unskilled labor and reduce demand for skilled labor and machinery → Economic Growth Evidence? → Solid Evidence across countries and over time showing negative realtion between inequaltity and growth |
Composition of Demand
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→ Poverty has been shown to have an effect on malnutrition and malnutrition effects the ablity to work (muscle, wastage, increased illness, vulneralblity t infection) and to produce → reduces Income and Income Growth
Evidence? Evidence that show vicious circle of poverty, low-income-poverty, both for countries and individual households |
Poverty and Income Levels/Growth
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Most common policies used to target inequality/poverty
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1) Schooling/Education
2) Nutrition/Health |
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→ Private sector and market will generate the levels of schooling.
→ No need for education or schooling policy → Market of failures in te market for education and other markets (e.g. the credit markets) a) Credit Market Imperfections b) Externalities in Education c) Informational Problems |
Education
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→ As discussed lack of collateral means that is not possible to borrow against future education
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Credit Market Imperfections
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(i) Educated workers tend to make other workers more productive → underinvestment in education
(ii) Educated ( particularly mothers) → better health and lower fertility → underinvestment in education |
Externalities in Education
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Usually education decisions made by parents, but parents may be misinformed about benefits of education
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Informative Problems
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An _________ refers to the uncomepensated impact (positive or negative) of one person's action on the well being of a by-stander.
Ex: A negative externality - Smoking A positive externality - Education |
Externality
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Why do we need Education polices?
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(i) Externalities
(ii)Credit Market Imperfections (iii) Lack of informaiton between 3% to 7% of GDP gets spent on education |
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In Latin America bad use of resources spent on education
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(i) Spending disproportionate concentrated at the University level rather than going to primary and secondary schooling
(ii) Spending is concentrated in urban rather than rural areas where the market imperfections are likely to be more prevelant (iii) Public spending goes mainly to infastructure rather than to other important inputs such as teachers salaries |
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Illiteracy rates have come down from 26% in 1970 to 13% in the late 1990's.
Situation of illiteracy still dismal in Central America (between 20% and 30%) |
Adult Literacy Rates
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A little under 7 years of education on average in Latin American Countries, but under 5 years in Central America
But big differnce for those at the top/bottom of income distribution |
Average years of Education
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Of age eligible population
90% of age eligible students enrolled in primary school 67% of age eligible population in secondary schooling |
School Enrollments
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Captures the extent of deprivation by incorporating measures on enrollemnt, gender, equaltiy, and completion rates
Problems: 1) Demand Side - to little effective demand → opportunity, cost of education to high for many households |
Educational Performance Index (EPI)
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a) Subsidies to poor families (Progressa/Oportunidades, Families en Acttion)
→ Conditional cash transfers. Conditional in sending kids to school and provides health checks → Targetted to poor families, Example: The regional program b) Flexible and practical Education system → Flexible schedule → Practical application to the type of work that children do |
Reforms/Policies on the Demand Side
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a) Provide market incentives to public schools
→ Introducing incentives for schools (P900 Program in Chili) b) School Vouchers → Subsidies provide school attendance or public municipal schools → Credit incentives for school to do better as some families turn to private education (voucher systems in Chili and Columbia) |
Reforms/Policies on Supply Side
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→ Flexible schedule
→ Practical application to the type of work that children do |
Flexible and practical Education system
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Local governments are better placed to determine what local schools need (answer)
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Decentralization
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Market imperfections in health insurance
→ Asymetric info for those who need most insurance are the very sick but these patients are the first that insurance decline or turn away Money is not allocated efficiently |
Health
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→ No Collateral and healthier individual can provide
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Credit Market Imperfections
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→ Contagious disease
between 5% and 10% of GDP goes to health |
Externalities
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Money is not allocated efficently
(i) Too much money spent on curative as opposed to preventive care (ii) Disporpionate amount of money spent in urban to rural areas (50%-80% of all health expenditures go to hospitals in urban centers) (iii) Spending disporpotionately concentrated in plant equipment and services, which take away from primary/preventive care |
Health
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Discounts the HDI for gender inequaltiy in life expectancy, educational and income by assigning a penalty for inequality between men and women
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Gender Development Index (GDI)
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→ Mixed system of health care
(i) Social security institutes - Provide health benefits to the formal sector employees |
Health Performance Indicators
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Lowers those who are uninsured and those who opt out of SSI's
Ministry of health covering the very poor |
Private Sector
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(1) Increased access to preventive care
→ educating women mobile units (ii) Privitization - Chili and Columbia (iii) Decentralization |
Policy Solutions with regard to Health and Private sector
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→ Latin American coutries started fallling behind in comparison to the U.S. and Canada
→ 1850 - Argentina and Brazil's GDP exceed that of Canada and that 65% of the GDP in the U.S. → 1913 - Canada's GDP reached 75% of that in the U.S. and Brazils' was only 15% and Argentina's 50% |
Export Led Stategy
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→ Argentina, Chili and Uruguay attraced European immigrants
→ Brazil and Cuba bought slaves from Africa → Peru bought Chinese workers (1) Export growth high in many countries 1850-1890 but by 1900's declines in export-growth for many countries (2) Export Diversification - Only Argentina and Mexico and Peru have had their top two exports comprising less than 50% of all exports. Endowements but also policy important in terms of what countries produced and how much they diversified |
Export Led Strategy
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Only Argentiana and Mexico and Peru had their top two exports comprising less than 50% of all exports
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Export Diversification
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Policy important in terms of what coutries produced and how much they diversified
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Endowments
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Why policy important in driving the economy in one direction or other.
Development economist Paul Rosenstein-Rodan advanced the concept of balanced growth. |
Complimentaries
Paul Rosenstein-Rodan (1943) → Economic under development is the outcome of a problem of coordination where several investments don't occur if investments elsewhere are not forthcoming → Failures of coordination are most evident when we consider various sectors linked from one another. (See notes of graph) |
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Linkages that facilitate the ease of supply of a product other industries → push factor
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Foward Linkages
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Linkages that increase the demand in other sectors
→ Pull factors |
Backward Linkages
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Refers t sectors where the higher the scale of operation, the lower cost of production
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Increasing returns to scale
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1950-ISI, From the time of independance to WWI
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Export Led Growth Strategy
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Very good for most countries 1890-1912 - Argentina, Chili and Mexico
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Export Performance
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Argentian and Peru leading export accounts for less than 25% of ll exports
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Export Diversification
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Peru- Copper
Bolivia - Tin Chili - Nitrates Brazil, Peru - Rubber Argentina, Uruguay - Wool Mexico - Henequen |
Production of other minerals and Agricultural products
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Columbia, Costa Rica, all other central Amercian Countries, tropical luxuries
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Export Led Growth Strategy
- Export diversification with regard to Columbia |
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Wheat, linseed, rye, barley, maize, beef, lamb, wool and hides
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Argentina
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Initially heavily dependant on Guano
→ Diversify after the collapse of Guano boom to the production: sugar, cotton, coffee, silver, copper, rubber (See Graph) → Relying in a single or a few commodities is a viable stratgy as one expericences a commodity boom, however commodoties are subject to cycles. They experience booms and busts so when busts hit the economy can no longer be sustained by a single commodity. WWI - Decline in Demand - Disruption of production and shipping. Exconomies also lacked geographical diversification in terms of exports. More than 70% of all exports went to the U.K., France, Germany and the U.S. |
Peru
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Decline in Demand - Commodity busts hit most countries.
- Disruption of production, shipping Economies also lacked gepgraphical diversification in terms of exports (Table 3.6)More than 70% of all exports went to the U.K., France, Germany and the U.S. - Decline in demand - Commodity busts hit most countries - Disruptiion of production shipping |
WWI
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- Decline in demand - Commodity busts hit most countries
- Disruption of production shipping - The countries that suffered the least were the ones that diversified geographically in terms of commodities:Argentina, Paraguay, Columbia, Uruguay - But also hurt by the adverse terms of trade - Price of exports, fall more than price of imports so government revenues decline and spending in infastructure also falls. |
WWI
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1) Some countries continued to produce the same things and export to same locations.
2) A few countries shifted to production of strategic raw materials needed for the war |
Reaction from WWI
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Continues to effect demand for many of the goods produced in Latin American countries
Coffee fell by 40% between 1929 and 1930 Price of sugar fell by 60% between 1929 and 1930 |
1929 - The Great Depression
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Moving towards non-durable manufacturing products
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Moving towards other products after Great Depression and WWII
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- Argentina; Textiles automobiles, chemicals
- Brazil; Pig, Iron, Chemicals - Chili; Textiles, equipment Mexico; Textiles Peru; Textiles Uruguay and to a lesser extent - Columbia - Venezuela |
Industrial Sectors Developed
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Argentina manufacturing sector was 20% of GDP
Chili and Uruguay - 12% and 16% Brazil, Mexico, and Peru - between 8% and 10% |
After WWII sectors to survive but faced a competition from Western Europe and North America
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Heavily influenced by advice from Economic Commision for Latin America nad the Carribean (ECLAC)
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Turn to policy thinking around 1950's
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Advises countries to follow an Import Substitution Industrialization.
Influenced by postulates dependancy theory |
Raul Prebisch, Economist
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Postulated that center or industrialized countries defined rules of the game and perifery countries that were pawns in the Int'l pursuit profit - Industrialized countries wanted to extract natural resources - exploit labor in the world so richer countries could keep getting richer
Structuralists advocated the move away from primary products to more sophisticated products. - Local elites performed alliances with international capitalists to gain access to short-term profits |
Dependancy Theory
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Options?
1) Perifiery countries should overthrow local elites and break ties with core countries 2) Perifiry countries to change focus from primary towards sophisticated products, since it was the nature of the commodities they produced that put them at an advantage. |
- Core countries extracted natural resources and exploited labor t make profits and government richer at the expense of making perifiery countries poorer
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The United Nations Economic Commission for Latin America and the Carrbean (ECLAC or CEPAL). It was established by the UN Economic and Social Council in 1948. It disseminates economic and social information. It has little decision making power but provides a second opinion for governments' economic and social policy.
Advocated the moderate view, ie. but needed government involvement to overcome market failures associated with the production of sophisticated products: - Coordination failures associated with pressure - Increasing returns to scale in production lending sectors |
UNECLAC
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a) Formulation/establishment of state owned enterprises with focus on lending sectors (e.g) heavy industry and social infastructure
b) Aid private sector by: 1) Reducing taxes 2) Providing subsized credit c) Selective foreign direct Investment (FDI) - Provided necessary machinery and equpment to produce in industrial sector |
Import Substitution Strategy
Industrial Policy |
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a) Imposing barriers to trade
- Increased tariffs, ie. taxes on imports - Imposition of quotas b) Regional integration to enlarge the size of the market - Customs unions - Free trade area |
Import Substitution Strategy
Trade Policy |
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→ 6 countries with implemented/adopted inward-looking model.
- Argentina, Brazil, Chili, Columbia, Mexico, Uruguay → 3 countries started with ISI but moved away from it - Bolivia - 1952 Paraguay - 1954 Peru - 1948 → The rest of the 11 countries stayed with an Export Led Growth Strategy → Established state owned enterprises and these proliferated from the 50's to the 70's → Focused on lending sectors requiring substantial investments - Public untilities (gas, water, electric, telephone) - Heavy industries (oil, petrochemicals, steel, aircraft) → Share of manufacturing in GDP by 1960's was large as that in developed countries → Also private sector developed with support from government but mainly in non-durable sectors, (textiles, food processing, paper) → Hope was to move towards the production of durable intermediate goods (i) Lacked access to additional finance (ii) Lacked technology required to mount production of very sophisticated products But very inefficent industry, from competition and faced a captive market that was forced to produce expensive low quality goods → But while industrial sector was meant to replace imports, the industry itself was dependant in imported equipment and machinery → Selective FDI - Attracted multinational corporations, (MNC's) in certain reserved sectors, but also requiring the use of local imputs → But, for countries to attract MNC's, they needed to offer favorable condition, e.g, Brazil, offered even more favorable conditions to foreign than local firms → But MNC's also ended up producing in sectors in which local producers were already present: - 15-42% in food processing - 14%-62% in textiles >90% in tobacco sector → For those countries that opted to stick with ELG, this period benefited from commodity booms due to the Korean War → Restrictions imposed by developed countries on primary products → Price estabilization agreements moderated both price decline as well as price increase |
Industrial Policy
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a) Barriers to trade
(i) Tariffs (ii) Quotas Argentina - 131% Brazil - 168% Columbia - 112% Chili - 138% Mexico - 61% Uruguay - 21% Compared with 13% from western Europe and U.S. |
Trade Policy
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The bigger the scale of operation, the cheaper it is to produce and learing by doing. (The longer you produce, the cheaper it is to produce)
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But benefits from protecting infant induatries in the long run because:
Increasing returns to scale |
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Protecting sectors with foward and backward linkages
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But benefits from protecting infant industries in the long run because:
Complementaries |
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(ii) Idea behind regional integration was to enlarge the size of the market so that protected. Leading sectors could take advantage of Increasing Returns to Scale
Two options: a) Free trade Area - Abolition of all trade barriers betwenn countries, but leaving each country free to impose International tariffs and quotas to third countries - Customs Unions - Abolish all trade barriers between coutries but set commom external tarriffs |
Regional Integration
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Established in Montevideo in 1960-included 10 countries and Mexico
- The goal was not totally acheived even by 1971 |
Latin American Free Trade Association (LAFTA)
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1969 and Included the Andean countries of Bolivia, Chili, Columbia, and Peru
1973 - Venezuela joins 1976 - Chili withdraws → Customs union |
Andean PAct
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Central American common market (CACM) formed in the late 1960's among central american countries - commons union
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Regional Integration
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Expansion of intra-regional trade
- 12.5% in 1965 - 18% in 1975 Why did a greater attempt at regional integration work? (i) All countries producing the same goods for the most part (ii) all countries being hit by the same shocks |
Trade Blocks
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→ Government failed to indenify right leading sectors, ie. sectors with lots of backward and foward linkages
→ Very inefficient manufacturing sector-high prices and low quality goods → Countries focused on production of non-durable goods → Instead durable and capital goods produced by MNC's, they are less likely to generate backward and fooward linkages since more likely to get inputs from abroad and to send goods for processing abroad |
Problems with ISI Strategy
Industrial Policy |
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Is the price at which foreign currency can be exchanged for domestic currency
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Exchange Rate
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→ Local markets too small to benefit from increasing returns to scale (IRS)
→ But also closing trade to the rest of the world, so market couldn't enlarge → Only redeeming feature of trade policy were efforts at regional integration, but regional integration didn;t have the desired effects of increasing size of market, because all coutries were producing same goods → Moreover, trade barriers had an additional preverse effect - the trade barriers appreciate the exchange rate. |
Problems with ISI Strategy
Barriers to Trade |
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Focused on an outward orientation by with substantial governement intervention
1) Industrial Policy - Provide subsidies to exports rather than to import substitutes (i) REduced import duties or quotas for exporters (ii) Provided preferrrential credit - Banks directed on easier terms for exporters In the short-run, ad valorum tax generates welfare losses → But in the long-run, South-East Asia producers benefitted increasing returns to scale and from learning-by exporting which made producers more efficient, ie, they could produce mkore at a cheaper cost → increased welfare → But also generated and appreciation of ht eexchange rate → By contrast to LAC, South East Asian Tigers used monetary policy to keep exchange rate in check |
Export-Promotion Strategy
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a) Public Utilities
b) Mining Industries c) Oil Sector d) Intermediate and Capital Goods (ii) Providing subsidies to private sector-mainly for production in non-durables. But these sectors got unconditional subsidies (iii) Government expenditures → National Security → Socal expenditures - rose sharply because socal reforms |
LAC started generating big governemnt deficits on spending side.
Finance the expansion of SOE's (State Owned Enterprises) |
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→ Revenue came mainly from indirect taxes from import and export duties but bacuse of the overvalued exchange rate there were little exports
→ Undertook tax reform and shifted to direct taxes Ex: In Nicargua 0.2% of populaiton paid taxed at the time |
LAC started generating big governemnt deficits on spending side.
On Revenue Side |
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a) SOE's (State owned enterprises)
b) Private sector subsidies c) Governement Expenditure Revenues were very small-export revenues not sufficient enough and little revenues from income taxes due to the tax evasion Had to borrow heavily 1) Borowing from abroad 2) Generating "Seniorage" (through inflation) 1960's and 1970's- International financial system was desperate to lend to the rest of the world |
Budget Deficits Spending
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External Debt - Borrowing from abroad increased drastically due to the following reasons:
(i) The spread of branches and representative office in Latin American markets meant that there was more info on local condition and profitable lending opprtunities (ii) Flow of petrodollars as a result of oil prices increases in 1970's meant that needed to recycle deposits into banks Negative real interest rates and short term of politicians meant that borrowing has a large incentive to borrow 1974; -22% 1975; -2.9% 1976; -1.2% 1977; -1.4% By 1982, LA countries had borrowed $30B but by this time real interst rates had gone up again and LA were having problems even paying interst on loans |
Debt Crisis - External Debt
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1) Debt Trap
→ Excessive borrowing but excessive borrowing on its own is not a problem if one invests on productive activities and this allows one to pay back loans. → But governments caught in debt trap 2) Unfavorable External Conditions |
Debt Crisis, What generated the debt crisis?
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Arise when unproductive investments or investments with very long horizons do not generate returns in time to service loans
a) Corruption → Mega projects with little investment value → SOE's are filled with names of dead people in the their payrolls b) Unproductive investments - Investments in projects that were largely unproductive - SOE's subsidies for private sector c) Long-term Investments - Some productive investments that didn't generate returns in time to pay back loans |
Debt Trap
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1) Debt crisis precipitated 2nd oil shock, which unravels a world eceonomic crisis and reduces demand for LA products
b) In 1979, Paul Volcker is appointed Chair of the Federal Reserve - Volcker implements contractionary policy to lower inflated and increased real interest rate to 8.1% by 1981 c) Given that loans were dominated in dollars, so given the danger of the peso being devalued may Latin Americans rushed to get their money out of these countries → capital flight reduces tax returns 1982, Mexico announces that it is no longer going to service debt-foreign banks stop lending altogeher to the region. Inital Reaction: 1982-1985 1) Baker Plan: 1985-1989 2) Brady Plan: 1989 - |
Debt Crisis, What generated the debt crisis?
Unfavorable External Conditions |
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a) Multilateral reaction (involving international organizations as well as U.S. and European governments)
→ Initially saw this as a problem of illiquidity rather than as a problem of insolvency → Reduce absorption: - reduce government spending and consumer spending through import suppression → Contractionary monetary policy since seniorage was generating inflationary pressures |
Initial Reaction: 1982-1985
1) Baker Plan: 1985-1989 2) Brady Plan: 1989 - INITIAL REACTION: 1982-85 |
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Initially this was seen as a problem of illiquidity rather than solvency.
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Inital Reaction from Int'l community (1982-85)
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→ Loan conditionality → provide loans as long as countries adopted;
- Fiscal responsibility - Contractionary Monetary Policy - Encourage exports by reducing tariffs and quota's (Inherently contactionary policy) |
IMF (International Monetary Fund)
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(i) Loans are assets that can be sold to more risk invclined buyers at a discount
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Market Reaction (Private Sector); Secondary Market for Debt
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Used to convert external debt into ownership of real assets, e.g, SOE's exchanged for debt
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Debt for equity swaps (DES)
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→ Used to convert external debt into a committment to invest in the environment and education
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Debt for Nature Swaps and debt for scholarship schemes
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Secretary of the treasury - James Baker announced a plan to jump start these economies → chenged policy from austerity to growth!!
→ Targeted 15 countries and gave $29Billion in new money but too small of an amount compared to the $1Trillion in debt obligations |
Baker Plan - 1985-87;
1987 Brazil declared a moratorium |
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Secretary of the treasury Nicholas Brady introduces a new plan offering 3 options.
1) Decrease face value of debt )preferred option by most countries) 2) Extend period of obligations 3) Infusion of new money Reduced face falue of debt by swapping old loans for 30 year national bonds with 30-35% discount of face value, backed by U.S. This restored investor confidence |
The Brady Plan - 1989
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M x V
M) Equity of Money in circulation V) Velocity of money - number of times per year a unit of currency turns over to purchase goods and services. |
Inflation
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During ISI it became common to finance large budgets through seignorage
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Why do monetary authorities print money?
- Finance Deficits |
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Excessive borrowing from abroad meant countries were having a hard time servicing their debt. Printing money to purchases foreign exchange and pay back debt.
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Why do monetary authorities print money?
- Service Debt |
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During recessionary period or periods of slack demand quantities produced fall but prices don't fall (e,g, wages) - → monetary authorities end of printing money to have accomodate demand for money
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Why do monetary authorities print money?
- Cost-Push Element - Inertial/Infaltionary expectation |
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When people export for inflation to keep going up, then the velocity of money increases because pople have an incentive to transform their rapidly worthless money into goods
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Why do monetary authorities print money?
Inertial/Inflationary expectation |
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Cost puch elements and inflationary expectations seen as main causes of inflation
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(Different Approahes)
Brazil: |
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- General Price Feeze
- Partial wage freezes, of consumer price increased then wage increased allowed - Indexation of wages to inflation. - Inflationary expectation. New currency introduced - Cruzado Introduced a set of 1000 cruzeiros and exchanged rate fixed at 13.84 cruzados/dollar - It worked at first! Inflation down came from 480 a month to 4.5% by, rose by 1% in May. But given real wage increase and increase in demand, but still slack supply → prices go up again and inflation goes back to 3 digits by December 1986. |
(Different Approahes)
Brazil: (i) Jan 1986 Cuzado Plan |
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Partial Wage increased → but wages adjusted every three months
- Cruzado devalued through a series a mini devaluations - Interest rates targeted close inflation - Control of budget deficit but political pressures made it difficult to reduce deficit - Novo Cuzado intoroduced → but plan doesn't work because of accomodating monetary policy and failure to reduce budget deficits |
(Different Approahes)
Brazil: (ii) Mid 1987 - Bresser Plan |
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"Kill inflation with one bullet"
- Freeze wages and prices - New monetary unit - Cuzeiro - Contractionary monetary policy - money supply down by 80% -Froze accounts with more than $1000USD - Reduciton in size of government by privatizing SOE's - But, Collor de Melo charged with corruption and confidence in government erodes, so infaltioary expectations built again |
Different Approahes)
Brazil: (iii) 1990 - Color de Melo Plan |
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Wages, prices taxes and exchange rate all denominated in a new accounting unit - URV (Real unit of value)
- Tightened monetary policy - Emergency fiscal adjustments take place - New currency- real pegged 1-to-1 with URV |
Different Approahes)
Brazil: (iv) 1993 Real Plan |
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Budget deficits, tax eroision and debt problems seen as the main problems of inflation
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Different Approahes)
Bolivia: |
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Elements of the Plan
- Devaluation of exchange rate - Fiscal adjustments- scaling down of SOE's and massive privitization - Tax reform to increase government revenues - Rescheduling of debt - Liberation of trade and capital flows General strike: - Find funding from Inter-American Development Bank to finance and Emergency Social Funds (ESC) |
(Different Approahes)
Bolivia: - 1985 New Economic Policy introduced by Victor Paz. Estensorr with advice of Jeffery Sachs |
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Cost-Push elements and inflationary expectaitons were seen as main causes in 1980's, but in the 1990's changed their focus towards fiscal deficits, tax eroision and the debt.
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Different Approahes)
Argentina: |
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- Wage Plan
- Introduce a new currency - Fiscal adjustments Initially it works! Brougt down inflation from 350% to 20% but credibility of plan falls apart when reduced imports generate an overvalued exchange rate |
(Different Approahes)
Argentina: (i) 1985 Austral Plan |
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(Menum, administration under cavallo)
- Elements of Plan - Locked Argentian peso to the dollar - Independent currency board up increase meontary supply if USD revenues rises - Promotion of exports and FDI - to increase stock of $ in Argentina - Dramatic Fiscal Adjustment - Large scale privitizations (51 SOE's are sold between 1989-92) - Tax reform to increase governement revenues - Inflation falls from 3000% to 0.1% in 1991 → GDP growth increases to 4.6% (Anything above 3% is high) |
(Different Approahes)
Argentina: (ii) 1991 Convertibility Plan |
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Focus on cost-push elements, inflationary expectations and also in fiscal deficits and debt all seen as causes of inflation.
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Different Approahes)
Mexico: |
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- Fiscal reform - Privitzations of SOE's
- Budget cutting - Trade liberazation - Exchange rate fixed - Explicit price agreements between business labor and government to cooperate in terms of controlling price increases. |
Different Approahes)
Mexico: (i) 1987 - Pact for economic solidarity) |
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(i) Reductings in non-tariff barriers
(ii) Reductions in average level of tarriffs (iii) Reductions in dispersion of tarriffs (iv) Depreciation of exchange rate |
5 Areas of structural Reforms
- Trade Reforms |
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(i) Consumption taxes introduced
(ii) Reduction in the marginal tax rate for income tax (iii) Reductions in corporate taxes (iv) Decreased reliance on trade taxes |
5 Areas of structural Reforms
- Tax Reforms |
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- Capital Market repression and little access to credit which implied reliance in foreign capital markets
- High reserve requirments - Interest rate ceilings imposed - governments allocated credit arbitrarily - New financial institution faced substantial barriers to entry |
5 Areas of structural Reforms
-Financial Liberalization/Capital market regulation |
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- Trade Liberation
- Tax reforms - Privatization - Financial Liberalization - Labor Market Reforms |
5 Areas of structural Reforms
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- Between 1990 and 2000, real reserve ratio requirements reduced in 15 countries by 20 points or more
- Freed up money for banks to lend out - At the smae time, that reserve requirments were lowered, prudential regulation introduced in accordance with the Basle Accords Basle Accord demands that reserve requiremnts discount for deliquent loans, exchange rate fluctuations and other factors that affect the level of risk faced by a bank |
Financial Liberalization
(i) Lower reserve ratio |
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(iii) systems of mandatory lending and mandatory investments were eliminated
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Financial Liberalization
(iii) |
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Controls on interest rates were dismantelled in all countries prior to 1995
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Financial Liberalization
(ii) |
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Privateizations of government banks and opening of the sector to foreign investment
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Financial Liberalization
(iv) |
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- Labor reguations (e.g payroll taxes) encouraged the creation and increase in the size of the informal sector.
High dismissal costs reduced the ability of firms to adjust to fluctuations |
Financial Liberalization
(v) Labor Reforms |
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Countries (Argentina, Columbia, Guatemals, Panama, Peru and Venzuels introduced measures to:
- Reduce payroll taxes - Reduce dismissal costs |
Labor Reforms
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Main objective was to reduce anti-export bias
- _________ to have the following effects: a) Lowered price of imported goods and in turn reallocation of production form import-competing sectors towards sectors with a comparitive advantage b) Reduce anti-export bias and encourage level and diversity of exports |
Trade Liberation
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(i) Exit of unproductive firms
(ii) Existing firms increase efficiency if they want to survive in the competitive environments (iii) New entrants are more productive because of tougher competition Degree of openess is positively associated with productiviity growth |
Evidence of trade reforms on productivity
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Argentina - 1.91
Bolivia - 0.11 - Chili - 4.96 - Costa Rica - 3.25 - Mexico - 0.32 (Includes agriculture, still heavily protected) But, productivity growth in Mexican manufacturing does show increased productivity after liberalization: Period 1940-50 - 0.46 1950-60 - 0.53 1960-70 - 3.00 1985-89 - 3.4 |
∆ Changes in productivity growth from 1978-82 to 1987-91
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(i) Change in the relative price of trade bias to non tradeable goods
(ii0 Reduciton in the cost of imported capital intermediate (iii) Devalued exchange rate reduced anti-export bias Volume of exports increases from 2% in 1970's 5.5% in 1980-85 6.7% in 1986 - 1990 |
The reduction in anti-export bias worked through a number of channels
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Free trade areas between Argentian, Brazil, Uruguay, and Praguay in 1991
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Move back to regional integration with formation of trade blocks:
(i) Mercosur |
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REvitalized in 1992
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Move back to regional integration with formation of trade blocks:
(ii) Andean Pact |
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In 1991
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Move back to regional integration with formation of trade blocks:
(iii) Cental American Common Market |
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Free Tade Area between Mexico, U.S. and Canada in 1993
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Move back to regional integration with formation of trade blocks:
(iv) NAFTA |
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a) Reduction in level and volititlty of fiscal deficits
- Shift focus on taxes from trade taxes and seniorage growth towards a more broad based consumption taxes and lower tax rates on income (i) Increase government revenue. Average public sector deficit in region fell from 6.5% of GDP (1980-1990) to 2% of GDP after 1990 (ii) Reduce volitilty of fiscal deficits as revenues as less dependant in trade taxes Volititlity of fiscal deficits in the region fell by 15% b) Reduce distortions on savings and investment and increase growth. - Evidence that shifting from income to consumption taxes encourages savings |
Tax Reforms
Should have had two effects |
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Should have had the following effects:
a) Reduce deficits, reduce government spending and increase government revenues. |
Privatizations
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Public Finances:
- Provide liquidity in short term - (ii) Increase revenues in long term - when in case SOE's unprofitable to begin with and privatized firms become profitable (ii) Reduce government expenditures permantely. "Evidence" - Mexico initial phase 1983-1987 generated close to 3 billion and 2nd phase; 12 billion - Argentinian privatizations generated close to $18 billion (1989-1992). They rediuced share of public deficits as % of GDP from 6.5% to 0.06%. Also reduced face value of debt by $14 million. But how much privatizations helped government finances depended on mode of privatizations. 4 MODES: - Sale of % of shares to private comapny or consortium (ii) Initial Public Offering (iii) Employee Layout (iv) Liquidiation and sale of assets Evidence: - Chili, which was a pioneer in area of privatizations relied primarily on (i) by selling to Chilean Conglomerates - Mexiso allowed employee buyouts and allowed unions to buy a % of firm at a discount - Argentina stated privatizing unsing strategy (i) but moved to (ii) by holding auctions |
Privatizations: Public Finance
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b) Increased efficiency of privatized firms and increased welfare for consumers.
- Should expect increased efficiency and reduced prices as a result of privatizations - Evidence on Productivity: - Mexico's telephone company in TFP of 15% in 1991. - Aeromexico and Mexicana - More than doubled labor productivity between 1981 and 1990. - Mexico deregulation imports in mid 1991 decreased costs by 30% and increased volume of containers handeld by 50% Chili: Significant but small gains of privatizations frims in Chili Argentina: In railways, there was a huge increase in labor productivity as total labor force declined 95,000 to 5,000. Columbia: 3 privatization of an automobile plant, a collection agency and a bank shows large increases in productivity |
Privatizations: Efficiency and Welfare
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Argentina: Water prices declined and quality of service increased after privatization of water company - in child mortality due to better access to drinking water
Columbia - Reduced prices in automobile and banmking sectors suggest increased welfare of consumers Argentina and Mexico - Privatization of ports reduced shopping costs by 50% Mexcio - Prices go up after privatization of telephone company in Mexico. Some contries introduced regulatory framework along with privatizations to take care of market. Imperfections in some sectors (I.e. utilities, are for most part natural monopolies) |
Efficieny and Welfare:
Consumer Welfare |
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Poverty line set at $720./year or $60./month or $2.00/day.
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UN Economic Commision for Latin America and the Carribean (ECLA)
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1) Trade Lberations: Productivity ↑, Export ↑.
2) Tax Reforms: Level of volitility of budget deficits ↓. Savings and growth (very little effect). 3) Privatizations: Level of budget deficits ↓. Productivity and consumer welfare ↑ 4) Capital Market Deregulation - Eliminate Interst rate ceilings ↓ reserve requirements Eliminate mandatory lending and investment. Effects of Capital Market Deregualtion: a) Increase in level of investment and in turn on growth - Private investment in Latin America didn't increase after capital market deregulation- Saving in Latin America the lowest i the world and didn't change after the reforms b) Composition of Investment: Composition and quality of investment changes because better working financial sector in terms of informaiton on promise of financial projects. Avoids making bad loans and having a lot of defaults. Evidence on changes in composition of investment. - Chili: Investment in agriculture and manufacturing which resulted in a surge in productivity and growth in exports. - Mexico: Petrochemical sector grows significantely - Argentina: Ports and roads duw to investment in infastructure. Country level studies Ecuador, Chili, Mexico, and Columbia → After financial market. Deregulation productivity of small firms. 5) Labor Market Deregulaiton. Effects of Labor Regulations: Expected effect of lowering dismissal costs is to (i) increase turnover- both thorugh increased dismissal and hires. (ii) Increase the size of formal sector and reduce underground activity Evidence: (i) Reductions in dismissal costs in Columbia, Peru, Argentian, increase hires and seperations (ii) Reduciton in distortions increase formal sector employment by about 5% in countries that reduced dismissal costs Expect effects of reducing payroll taxes- in terms of changes in composition of emplyment Evidence: - Some countries find no effect (Chili) - Increases in formal employment (Columbia) |
Structual Reforms
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Even before the structural reforms, the period of ISI (1950-1970) was uncharacterized by increasing inequality (Gini Coefficient ↑ 1950-1970's)
The period of the debt crisis, which erupted in 1982, worsened this battered social picture in Latin America |
Distribute effects of Structural Reforms
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(i) Faster growth is the main determinant of poverty reduction and reduced inequality
a) Faster growth increases employment opportunities b) Faster growth increases productivity and earnings (ii) Macro-economic stability affects poverty: a) Overvaluation of exchange rate hurts labor-intensive export sector. - More variable inflation if negatively realted to Gini and poverty rate b) The poor are more vulnerable to inflation tax. - Over-valuation of exchange rate increases inequaltiy and poverty rate (iii) Reduction in government spending in social programs increases poverty and inequaltiy → Reduction real income throughout the region. By 1991, only Chili and Columbia had a per capita GDP about what they had. → % of populaiton living below poverty ↑ in 16/20 countries in region between 1980-1989 → Inequality kept increasing in 14/20 countries between 1980-1989 → Likely works through labor market - unemployment alarming high during debt crisis and real wages i 1994 lower than in 1982. |
Why did the debt crisis affect poverty and inequality
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1) Trade Liberalization - Increased inequality. Why? Because Trade displaced individuals in unskilled intensive sectors
2) Tax reforms - Contributed in Latin America to increase inequaltiy. Why? Replacing progressive for regressive tax 3) Privatizations - Generated massive displacemnts, but of relativley well-off workers → Little effect and perhaps a reduction in inequaltiy 4) Capital Market Reforms - Contributed to increase inequaltiy because mandatory lending eliminated 5) Labor Market Reforms - Reduced inequality (more hires and better quality jobs) |
Effects of Structural Reforms in terms of poverty and inequality
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1)Need to increase the size of the export sector and need to increase diversity
2) Neeed to unertake fiscal reform both in terms of rediucing expenditure and increasing revenue 3) The need to increase availablity of inputs (domestic) |
Lessons from 1990's
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1) Trade reforms → aiming to prmote exports
2) Tax Reforms → solve problems of fiscal deficit by increasing revenues 3) Privatizations → expenditures 4) Financial Liberalization → access to capital 5) Labor reforms → easy adjustment |
Measures taken in 5 main areas
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Protectionism from ISI period discouraged export→promotion and created ineffient national industry. It also overvalued local currency reforms:
1) First reforms in 1970's was Chili( 1975-1979) - Uruguay (1978-1986), - Bolivia and Mexico (1985-1986)→ with other reformers following in late 1980's and early 1990's. |
Trade Reforms
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Redirection of non-tarriff barriers - whcih include quotas and prohibition. → reduce coverage of non-tarriff barriers.
(ii) Reduction of average level of import-tarriffs → average levels fell from 48.9% duting pre-reformed years to 10.7% by 1990's. (iii) Reduce the degree of dispersion of the ratiif structure → less uncertainlty and reduce preferrential treatment → Chili applied uniform tarrif across sector to avoid any lobby networks (iv) More control of the exchange rate local currencies were depreciated substantially by 1991 in an effort to promote exports |
Trade Reforms; specific Measures
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- Problems before social reforms
- Ineffective sytem in terms of collecting revenues - Distortioanry taxes discouraged savings and investment in the formal sector of economy → Reforms tried to improve collectons and simplify adminitration and seek neutrablity measures (i) Introduciton of value added tax which is a tax on consumers Advantages: - Easier to Collect - Less distortionary - More regressive tax (ii) Reduction of all marginal tax rates and personal income (iii) Corporate taxes were reduced but preferrential treatment in mining, forestry, and tourism (iv) Reducing reliance on taxes on foregin trade 18% of tax revenues |
Tax Reforms
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This was made to reduce expenditure because during ISI imports of 80's are steadily growing between 1950's-1980's.
- By 1970's, SOE's had grown beyond and so-called strategic sectors and did not face enough demand and take advantage of increasing returns to scale. → By 1990's SOE's imposed a big burden on public deficit - and fueled information. → Sale of SOE's was seen as a way to generate short term liquidity and reduce government expenditures on a perminant basis between 1986-99, 396 sales or transfers put sector which representing 30% of privatization in developing world. → Bolivia, Peru, Brazil high generated a lof short term insurance. this also led to increase in FDI. In 1990's 36% was FDI. |
Privatizations
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Reason: Capital market repression and little access ot credit, which implied reliance of foreign capital markets
→ There was high reserve requirement → Interest rates were subject to control → Government allocated credit arbitratry → new financial institutions face substantial barriers to entry Reforms: Aimed to eliminate then problem (1) Lowere reserve ratio between 1990 and 2000, real non profit barriers→ whciha re quotas. |
Financial Sector reforms/Capital Market Regulations
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- Overspending by government
- Restricted monetary policy - Unsustainable Domestic Policy * Populism: Promoted growth and income distribution but ignored risks of increasing debt, inflation and external contrains. Corruption ie, Juan and Eva Peron in Argentina * Overcapacity: Budget Deficits * Low interest rates discouraged savings - Budget deficits - Low interest rates discouraged savings - Oil Shocks - External Shocs, central banks engaged in seignorage creating inflation |
Explain to the government why they got into the debt crisis
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1. Magnitude of capital flows
2. Types of capital flows 3. Benefits/cost of capital flows |
Financial crisis
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- After structural reforms there was a huge influx of capital into LAC
- By 2000 capital flows [both inflows and outflows] were 25times higher than they had been in 1970 - But while capital in flows very high, capital outflows just as large. Concentrated in some countries, while other countries didn’t receive any capital - While private financial capital increased foreign gov’t aid decreased -both demand and supply factors affected this flow Demand: 1. Uncertainty: demand depends on anticipation of returns in future, expected value of assets -uncertainty of future performance of asset very high in LAC - w/structural reforms, uncertainty fell and foreign investors became much more willing to invest in LAC 2. Returns to other Assets- investors make decisions based on the relative returns and returns to other assets fell during this time period (eg. Returns to assets in the US, Europe and Asia) -low interest rates in the US made investments in the US unattractive -both supply and demand factors affected this flow Supply: 1. Technology contributed to reduce transaction costs and increase financial capital flows towards LAC 2. Aging of baby-boomers meant that they were looking for invest opportunities. |
Capital Flows
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a] bond purchases
b] portfolio equity c] FDI |
Types of Capital
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Portfolio Bonds: government bonds, corporate bonds
-involves a promise to pay in the future/ given interest - purchases of bonds in LAC increased 188times b/w 1990-9 |
Portfolio Bonds
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b] portfolio equity- equity investments in country funds depository receipts and purchase of domestic firms by foreign investors
-purchases of equity increased by 3.5 times during 1990-9 (largely b/c underdeveloped or absence of stock markets in many of countries / (Chile’s stock market similar to France’s and Brazils similar to Spain’s, but the had very small or no stock market) |
Portfolio Equity
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1) Host-mkt serving- foreign firms are trying to capture the local mkt (Mexico, Brazil, Argentina)
2) Export orientation- foreign firms more to get access to cheap materials and labor and then export to the rest of the world - Mexico CAC and Caribbean basin- cheap labor and laxer labor/ environmental regulations - Colombia, Venezuela, chile, and peru- as places where there are cheaper materials 3) Infrastructure building, provide infrastructure for public utility projects - colombia, venzuela, peru,- FDI came in to build infrastructure for telecommunications, electricity generation and even in oil sector |
Reasons behind FDI:
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Foreign firms coming to produce in the country - it is perceived as a more permanent that either of the two previously mentioned capital
- FDI increased 10 times b/w 1990-2000 - FDI accounts for 2.2% of GDI |
FDI
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1) source of financing lor local investments
2) Provision of infastructure 3) FDI spillovers, the backward and foward linkages and transfers of technology |
Benefits & Costs of Capital Flows: Benefits
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1) Short-term flows generate volititlity an duncertainty which may drive local capital away (capital flight)
2) Large capital inflows appreciate local currencies and make exports less compettitive, generating current account deficits 3) Large inflows of money lower the interest rate, reducing incentives to save and for sources of financing |
Benefits & Costs of Capital Flows: Costs
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1) Mexcian Peso Crisis (1994)
2) Asian Crisis 1997, Asian Tigers 3) Brazillian Crisis, 1998 4) Argentinan Crisis 2000-2001 |
2nd half of the 1990's
→ A number of financial crisis |
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→ Triggered by devaluation of peso in December 20, 1994
→ Huge current account deficit or imbalance (5% of GDP in 1991 and 8% of GDP by 1994) → Trade deficit would be ok if using import and capital inflows to financee investments → But Mexican using funds to finance consumption and housing |
Mexican Peso Crisis
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→ Mexican government tried to react to this situation in a gradual manner by:
1) Enticing improvments in productivity in order to increase export competiveness 2) It counted on approval of NAFTA 1992 as a way to attract new FDI, however political events drive investors away (i) Chiapas revolts (ii) The assassination of PRI Presidential candidate, Luid Donaldo Colosio and of PRI secretary general, Ruiz Massieu (iii) Resignaiton of attorney general (iv) Assasination fo prominent banker → Given huge outflows of capital, exchange rate should had devlued but in the 1980's Mexico had established a fixed exchange rate policy (1-to-1 with dollars) as a way to control inflation |
Mexican Peso Crisis
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1) Raise interst rates but couldn't afford given upcoming election
2) Use stock if international revenues to put dollars into the economy 3) Introduced peso-dominated but dollar-indexed bonds called Tesobonos (bonds fromthe treasury) Capital inflows declined from 30 billion in 1993 to 10.2 billion in 1994 and International reserves fell from 30 billion in Feb 1994 to 5 billion in December 22, 1994 |
Options for Mexican government; Mexican Debt Crisis
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(i) U.S. Canadian and Eurpoean banks provided $7 billion in guarantees and back short-term tesobonos
(ii) Quickened the pace of privatization (iii) Banking system opened to FDI (iv) Interest rates rose by 55%, but this generated a recessionary drag |
Emergency measures: Mexican Peso Crisis: 1994
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On December 20th 1994, the Mexican govenrment abandons the fixed exchange rate and moves to a floating exchange rate at the risk of ignighting inflation.
→ Geneerates a loss of confidence in foreign investors and portfolio equity fallls drastically while Tesobonos are redeemed as quickly as possible → So called "Tequila Effect" means that loss of confidence by investors in Mexican economy spreads to rest of region → Bill Clinton in unable to pass an emergency rescue package through Congress, but gets $18 billion from IMF and $10 Billion from banks for International settlements suing oil reserves as collateral |
Emergency measures: (continued from (i)-(iv)
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→ In summer 1997, Latin America gets hit by a crisis not of its own making
→ New and in expreienced investors who loose confidence in "Asian Tigers" take out their capital out of all emerging markets → Currencies in Asian economics devalued sharply so Latin American exports became less competitive and trade deficits build up |
Asian Crisis (1997)
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→ When the russion ruble collapsed in 1998, uninformed investors pull their capital out of Brazil
- International reserves fall by $500 million in a day! |
Brazillian Crisis (1998)
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(i) Raise interst rates, inspite of intial reluctance due to Cordoso's upcoming re-election
(ii) Cordoso annouces a fiscal austerity plan which includes $20 Billion in budget cuts (iii) Keep using interantioanl reserves to defend the real (reeeall- Brazillian currency), but eventually forced to abandon fixed exchange rate (real devalued by 28%) (iv) Congress passes tax increases and additional expenditure cuts |
Responses to the Brazillan Crisis
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→ Argentina using capital inflows to finance consumption
→ Government unable to pass fiscal cuts through Congress → Argentinian exports not competitive (vis-a-vis Brazillian goods) international investors pull out |
Argentine Crisis (2001)
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→ Corruption is the extreme institutions.
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Weak Institutions
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Refers to the concession of public or government goods, services, or resources to certain individuals or favored groups in exchange for private gains or governement official
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Corruption (Definintion)
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→ Corruption is negatively correlated with negative growth and with investment into physical capital
→ Corruption may also have indirect effects which affect economic performances, eg.g. larger budget deficits |
Why do we care about corruption
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1) Centalized Corruption
2) Decentalized Corruption |
Two types of corruption regimes
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A government official organizes all corruption activity in the economy and determines shares of each individual offial in the ill-gotten gains
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Centralized corruption: Mexico, Paraguay, Uruguay
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(Visios circle - A little better) Take place when each government offical acts like an individual predator with out taking into account the effect of his actions on other predators
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Decentalized Corruption
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- Avaiblbilty of coca commodity windfalls and foreighn aid
- Restriciotn on trade - Low civil servant and salaries - Weak institutions and lack of enformcment |
What are the derminants of corruption
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Institutions are rules that shape the behavior of individuals in a
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society
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constitutions, regualaitons, contracts, laws. Informal-values and norms
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Formal Institutions
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Weak institutions reduces incentives to invest into physical and human capital and reduces entrepeneural activity because more uncertainty and less predectablility
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Subjective indicators of institutions
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- International country risk guide (ICRG) collect surveys from International and demestic investors on
1) Perceived risk of expropiation 2) Perceived degree of contract enforcablity 3) Existence of mechanisms for peacful 4) Perceive quality of bureaucracies 5) Perceived incidence or corruption |
Growth affected by institutions:
Directly |
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Weak institutions genrate policies in terms of other policies - inflation, budget deficits, trade.
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Institutions affect inequaltiy and poverty
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→ Institutions provide safety nets tha teh degree and severtiy of the incidence of poverty
→ But, also richer are better off because expected returns from investment and entrepreneurial activity higher |
Growth affected by institutions:
Indirectly |