Economic Survey of Latin America and the Caribbean 1997-1998

4. Policy lessons from the Asian crisis

The problems experienced during the past 12 months, as the Asian crisis began to have an impact on the Latin American and Caribbean region, point to a number of useful lessons that should be borne in mind. In the domestic sphere, these lessons relate to macroeconomic, institutional and competitiveness issues. Internationally, they include the need for greater coordination and regulation.

The main macroeconomic lesson refers to the need to concentrate on managing the economy during boom periods, since policy-makers have much more manoeuvering room before a crisis strikes. In periods of economic expansion, large capital inflows tend to result in increased public and private expenditure and in the build-up of large debts; the reversal of these flows is likely to produce a serious crisis. Since Latin American fiscal policy has tended to be procyclical in recent years, the possibility of using flexible tax and spending instruments that could decrease the volatility of growth should be explored. With respect to monetary policy, greater autonomy can be obtained through the use of mechanisms to discourage excess capital flows; such measures might include reserve requirements (such as those used in Chile and Colombia) or taxes (as in the case of Brazil).

In the institutional sphere, even though a great deal of progress has been made in the last few years, further attention needs to be paid to strengthening the region’s banks and improving prudential regulation and supervision. This includes the training of supervisors as well as the formulation of rules and regulations. Given the propensity to volatility exhibited by Latin America and the Caribbean and the high cost of financial crises in developing countries, a capital/asset ratio higher than the 8% required by the Bank for International Settlements would probably be appropriate. Even more important is the proper sequencing of financial liberalization and the establishment of an adequate regulatory framework. If liberalization precedes regulation, serious problems are likely to result.

Since the Asian crisis has not been limited to the financial sector but has instead extended into the real economy, a number of lessons concerning the latter may also be drawn. To judge from the Latin American experience in the last year, it is obvious that over-reliance on a few primary export products is still a dangerous tendency. Thus, in the case of several of the region’s economies, copper and oil exports offered a vulnerable flank through which both price and quantity shocks could penetrate. From the vantage point of Asia, a less obvious lesson focuses on more sophisticated "commodities"; even computer chips can suffer from volatility. Looking beyond the measures to be taken in connection with particular types of products, it is evident that monitoring markets to detect situations of oversupply is a high-priority task. Likewise, it is clear that competitiveness should be a constant concern and must not be taken for granted.

The current crisis has also focused attention on the high degree of instability characterizing financial markets at the world level, especially in their fastest growing segments, such as mutual funds and derivatives. There is a lack of coordination among the industrial countries that serve as the base of operations for the world’s main financial firms. No international institution exists that has the responsibility for coordinating and supervising these firms. The International Monetary Fund has insufficient resources for this task and no mandate. In the private sphere, credit rating agencies have tended to exacerbate instability rather than diminish it. This would seem to be a good opportunity to rethink international institutional arrangements, but a bad time to consider further liberalization of financial markets.

Of particular concern is the role played by short-term capital flows, since such funds can move out of a country just as rapidly as they come in. Even if all developing countries were to place some kind of restrictions on these flows, international supervision would still be needed because their volume is so large that they can overwhelm local economic policy measures. Moreover, the psychology of the market is such that the outflows may have little to do with economic fundamentals. While the Latin American experience of the 1980s and 1990s has shown that foreign capital can play a very beneficial role in supporting growth, it is necessary to design and implement a policy framework to reinforce its positive aspects while minimizing volatility. This may be the most important single lesson of the last 12 months.

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