Seeking growth under financial volatility

Foreword

This volume deals with macroeconomic issues and their relation to economic growth. It belongs to a line of research developed by ECLAC during recent years on the globalization of financial volatility, macroeconomic management, and growth.

This line of research has been encouraged by the frustrating GDP growth of Latin American economies since the 1980s. Even disregarding the so-called lost decade resulting from the debt crisis, in the subsequent period 1990 2004 growth averaged a disappointing 2.6% per year. One policy area associated to that outcome has been a short-legged macroeconomic environment, detrimental for both capital and labor performance. It has been dominated by highly unstable aggregate demand and misaligned exchange rates, frequently far away from trend levels. These imply an 'unfriendly' environment for investment decisions, commonly with 'wrong' prices for an efficient resource allocation. Our purpose in this volume is to analyze policy measures that contribute to avoid costly mistakes and to recover economic growth. We build on the reforms already made, making reforms to the reforms when necessary. We seek to achieve a macroeconomics-for-growth, or real macroeconomics.

This new book is the result of a research project coordinated by ECLAC, supported by the Ford Foundation, on Management of Volatility, Financial Globalization and Growth in EEs, studying the gestation and bust of the Asian crises and the contagion experienced by Latin America. Additionally, the country cases of Korea and Malaysia in East Asia under the Asian crisis, and of South Africa in the post-apartheid period were analyzed. These three countries exhibit features that make them especially relevant.

Capital flows have been at the core of the financial crises, macroinstability and, in general, the poor growth performance of EEs in recent times. The demand for "accountability" has grown recently, activated by the fact that, in the last seven-year period (1998-2004), the Latin American economies (LACs) grew only 1.7% per year on average and per capita GDP stagnated. The growth performance of South Africa is also dismal, though the causes are more complex than in Latin America. The six main East Asian countries performed somewhat better over that period, with a 3.3% average GDP increase, where the Republic of Korea and Malaysia stand out as two dynamic outliers. This average is, however, well below the 7 or 8% rates of their previous historical performance. In both regions, real macroeconomic instability --in terms of aggregate demand, interest rates and exchange rates-- has been present in an outstanding fashion. In fact, in these recent crises sharp gaps between actual and potential GDP and outlier exchange and interest rates have been recorded. Actual total factor productivity has contracted and the supply of physical and human capital has been discouraged. Several EEs have stepped down to lower growth paths; from Argentina, to Korea, to Malaysia or Chile.

Firms and labor, as well as tax proceeds, have been hit by real macroeconomic instability. Extreme macroinstability has been associated with strong swings in aggregate demand. For instance, all across-the-board changes in Latin American economic activity have been led by fluctuations in aggregate demand; the sharper swings in GDP have been endogenous to those changes in aggregate demand, all of which have been driven by capital surges. The recessive adjustments in East Asia in 1997-98 were also led by reversals of capital flows, which followed the voluminous previous inflows.

Of course, out-surges are not the only relevant variable; there are other international variables and many country specific, economic and political, variables playing around. However, for the Latin American region as a whole, capital account cycles have been notably strong compared to any combination of other domestic or external variables. The sudden stops in capital flows have been located mainly in flows other than greenfield foreign direct investment (FDI), and have largely been associated with the behavior of the private sector, rather than the fiscal accounts. We show that the private sector response has been, frequently, misled by a procyclical bias in macroeconomic policies.

We are convinced that the present volume is a significant contribution to this crucial concern of ECLAC: to develop a market economy capable to growth in a sustained way, in which both productivity and the welfare of people expand persistently, and are distributed in a growingly more equitable fashion. That is why we are highly indebted with the authors of the chapters of this volume and, particularly, with Ricardo Ffrench-Davis, the coordinator of this project.

José Luis Machinea, ECLAC Executive Secretary