The financial crisis of Latin America and the new international financial architecture
What began as an East Asian financial crisis in 1997 spilled over into Brazil in the following year and soon enveloped the whole Latin American continent. The social consequences of the resulting crisis were particularly severe especially in terms of employment and growth of poverty. Humberto Campodonico and Manuel Chiriboga contend that it is because of the fearful impact of such crises on developing countries that any discussion of the New International Financial Order must begin in this part of the world.
IN 1998 and 1999, the majority of Latin American countries suffered a severe economic recession that drove corporations into insolvency and thus forced many to close down. The recession also caused the deterioration of the banking system’s financial situation and massive lay-offs that increased the existing unemployment level and caused the loss of purchasing power among large sectors of the population.
Most analysts agree that the trigger for the crisis was, essentially, the enormous weight taken by short-term financial capital in the financial structure of emerging markets, including Latin America, as a part of the process of globalisation. The preponderance of this form of capital was the result of International Monetary Fund (IMF) polices that encouraged its inflow via the opening of the capital account of the balance of payments of many emerging markets1. As has been mentioned repeatedly by Joseph Stiglitz, former Chief Economist of the World Bank: ‘The drive toward liberalisation of the capital and financial markets, without the necessary attention to the design and execution of regulation structures appropriate to the circumstances, was based more in ideology than in economic science2’. This was a result of the pressure exercised by the US Treasury and the IMF3.
Hence, from 1990 to 1995, short-term capital inflows to emerging markets tripled (see table 1). While this flow was positive, emerging market economies experienced growth, since this capital financed imports, credits to the private sector, consumption credits for individual citizens and, also, the cash for external debt payments. However, short-term capital has a speculative, volatile and erratic character. This is evident from the abrupt decrease of the flows, which started from 1996, continued in 1997 with the Asian crisis, and deepened in 1998 with the Russian crisis and in 1999 with the Brazilian crisis. This decrease was truly spectacular: from US$31.2 billion to US$4.9 billion from 1996 to 1998. The same holds for Latin America alone: between 1997 and 1998, almost US$9 billion left the region.
The World Bank illustrates the problem by referring to South Korea: ‘In South Korea, excessive domestic financial risk taking - including low equity and heavy bank borrowing - was a long-standing practice. What may have tipped the balance in the 1997 crises, however, was capital flows; when, in the context of its entry into the OECD (Organisation for Economic Cooperation and Development), Korea liberalised the ability of its banks to borrow (short term) abroad (instead of tightening safeguards), there was a massive surge in such inflows; their reversal subsequently precipitated the crisis.’4
The same is remarked by Dani Rodrik, a well-known scholar from Harvard University: ‘In 1996, five Asian economies (South Korea, Indonesia, Malaysia, the Philippines and Thailand) received net private capital flows amounting to US$93 billion. One year later (in 1997), they experienced an estimated outflow of US$12.1 billion, a turnaround in a single year of US$105 billion, amounting to more than 10% of the combined GDP of these economies. By 1998, three of these economies (Indonesia, Thailand and South Korea) were mired in a severe economic crisis, the magnitude of which would have seemed inconceivable even to the most knowledgeable and insightful observers of the region just months before.’5
The Asian crisis spilled over quickly, via Russia, to Brazil - thus, to Latin America. Brazil had economic policies similar to those put forward in East Asia, maintaining high interest rates to attract capital, with the purpose of defending the fixed exchange rate tied to the dollar. The result had been a massive inflow of volatile capital, increasing Brazil’s vulnerability to external financial problems, such as those that would take place soon after the Asian crisis. During the summer of 1998, the Russian crisis increased fears about the health of the Brazilian economy and US$20 billion left the country. In spite of the negotiation of a support loan organised by the US Treasury and the IMF, the drainage continued and Brazil had to devalue its currency. The government allowed the real to float, abandoning the linkage to the dollar.
The Brazilian crisis spread quickly to other Latin American countries, where billions of dollars left the region in a few weeks, hindering trade exchange with the US. Consequently, Latin American countries suffered one of their worst economic recessions. The impact of the crisis was particularly violent in the region’s smaller economies such as Bolivia, Ecuador and Uruguay, but countries like Argentina, Colombia and Chile also suffered severely.
Effects of the crisis
Massive short-term capital outflows provoked a deep recession. If Latin America had grown 5.3% in 1997, in 1998 growth diminished to 2.3% and in 1999, regional GDP growth was a mere 0.3%. In some countries the crisis was particularly severe (see table 2). To assure a minimum of economic stability, the countries took ‘rescue’ loans granted by multilateral banks amounting to more than US$10 billion in 1999. As a consequence, emerging markets’ foreign debt increased. In Latin America, external debt is now US$750 billion.
Moreover, ‘rescue’ loans were intended to save and bail out the big international creditors’ investments, which were of a mostly short-term nature, thus increasing ‘moral hazard’. This means that investors continue their speculative activities, despite knowing that there are high risks. This is because they believe they have security in that, once a crisis explodes, the multilateral organisations will provide the necessary funds for their rescue.
The crisis has also diminished multilateral development banks’ capacity for giving social policy loans and for second-generation reforms. Indeed, the World Bank’s structural adjustment loans, which almost disappeared in 1996, increased to 39% of the total in 1998 and consumed even bigger amounts in 1999 (see Figure 1). In the case of the Inter-American Development Bank (IDB), adjustment loans increased from an average of 15.6% in the period 1961-1999 to 24.3% in 1999.
The crisis increased the country risk, which has a direct effect on the rate of interest at which Third World countries contract loans in the international capital markets. According to the UN Economic Commission for Latin America and the Caribbean (ECLAC), ‘after Russia’s moratorium of August 1998, the cost of the region’s external financing rose considerably, to almost 15% annually. It gradually diminished to 10.5% in April 1999, and then it increased to 12%. These rates reflect a perception of a high risk of carrying out investments in the region and in the last months, also reflected the rise of international interest rates. As for the terms of maturity for bond emissions in the region, it is appropriate to mention that they deteriorated to a 5-year average in the III Quarter of 1999.’6
The crisis also had an effect on the state budget. The recession diminished fiscal revenues and most governments opted to reduce social support programmes, as well as the size of the State (lay-offs of public servants and therefore an increase in unemployment). The World Bank affirms in a recent report: ‘In principle, social protection programmes should be anti-cyclical, but in practice it is difficult to protect targeted programmes because several forces unite during the crisis to press down the transfers toward the poor.’7 In Brazil for example, soon after the crisis, cuts took place in the areas of the agrarian reform budget, social protection, environment, food help and revenues to poor families.
In the social sector, the variation of GDP per capita diminished from 3.3% in 1997 to 0.4% in 1998, continuing its fall in 1999, when the decrease rate was 1.6%. According to ECLAC (1999), the number of new jobs diminished in most Latin American countries. Urban unemployment also increased from 6.3% in 1995 to 8% and 8.7% in 1998 and 1999, respectively. This last percentage represents the highest registered rate since the information became available for a significant number of the countries.
This deterioration of social conditions aggravated the living conditions of the population in terms of poverty and extreme poverty, as well as the inequality in income distribution. It must be emphasised that this situation could not be reversed even during the years of growth that characterised the 1990-97 period. This points to strong deficiencies of the neo-liberal model that has been applied in most of the countries in the region.
Indeed, the economic growth experienced between 1990-97 contributed very little to the eradication of poverty. As is shown in Figure 2, although the total level of poverty went down from 41% to 36% from 1990 to 1997, in none of the cases did it reach the level before 1980.8 The ‘lost decade’ (1982-90), due to the external debt crisis, wiped out the gains that had been obtained in the 1945-1980 period.
The picture is even more alarming when we consider the income distribution figures. Figure 3 shows recent calculations by the IMF on the evolution of the Gini coefficient (the higher the coefficient, the worse the income distribution) in different regions of the world. Latin America has the shameful privilege of having the world’s worst rate of income inequality, which has stubbornly persisted for decades at level of around 0.5.
The decrease in growth during 1998 and 1999 has worsened this situation, as seen previously.
The new international financial architecture
After the crisis, there was a proliferation of discussions regarding the effectiveness of the governance of the international finance system, or what is also known as the international financial architecture. Calls for change have been heard for many years now from very diverse sectors. Indeed, in contrast to national financial systems, the international financial system lacks appropriate regulatory instruments to avoid speculation, volatility and the erratic character of short-term capital.
Moreover, after globalisation and the opening of the capital account of the balance of payments accelerated the worldwide mobility of capital, there was no improvement in international law for regulating the transactions involving such capital in foreign exchange, stock and financial markets. Neither the IMF nor the Bank for International Settlements (BIS, which is headquartered in Basel) has this attribution for international regulation. This capital moves in real time and embraces the whole planet, covering the foreign exchange markets (more than US$1.5 trillion daily, according to the IMF), the stock and the bond markets. In the last few years the placements of institutional investors (mutual funds, pension funds) have increased in the emerging markets. These funds are characterised by their mixture of high risks and profits, as well as their high volatility. Even more speculative and volatile are the hedge funds, which are one of the main sources of concern for the tenants of the new international financial architecture.
The international financial and monetary system also lacks a lender of last resort, something that does exist at national level. Indeed, one of the main objectives of central banks is to strengthen and to avoid crisis in national financial systems. In the event of financial or monetary crisis, the central bank is authorised to act and decide accordingly. There does not exist, however, an international central bank that has the authority and the appropriate resources to intervene in crises that erupt in one or more countries. This is the reason why the Group of Seven (G-7) leading industrialised countries turn to the IMF and the other multilateral organisations so that economic measures can be taken to solve the crisis; these organisations are also asked to manage the monetary resources given to them to solve the crisis. In this case, two things are in question: first, how appropriate these organisations are in fulfilling these functions, and, second, the recipe of economic policies dictated by these bodies, which, in many cases, contributes to furthering the crises instead of overcoming them.
This debate has occupied a prominent position on the agenda since 1997. Declarations have been made by the leaders of the G-7 countries, their Ministries of Treasury and Finance, central banks, and the international financial institutions such as the IMF, the World Bank and the IDB. Recently, the Meltzer Commission of the US Congress recommended significant changes in the workings of the IMF and the World Bank, limiting their role and linking them strongly to the international capital markets. The United Nations and numerous regional organisations, such as ECLAC and the Latin American Economic System (SELA), among others, have advanced proposals as well. Also, there have been many proposals from academic sectors, such as that for a Tobin Tax (putting a tax on the circulation of short-term capital). Proposals have also been made by NGOs and labour unions.
The main debates about the necessity of a new international financial architecture can be organised around the following main topics:
a. The role of the IMF and the type of credits it can provide to the countries and their terms; its role concerning the impact on the poor; the degree of necessity of having mechanisms like the Poverty Reduction Strategy Paper (PRSP) and its supervisory role on the economies of all countries.
b. The role of the multilateral or regional banks in relation to poor countries as well as median-income countries; the relationship between these organisations, especially the IFC and MIGA, and the private capital markets.
c. The external debts of developing countries, including those covered by the Heavily Indebted Poor Countries (HIPC) debt relief initiative, as well as middle-income countries.
d. The control mechanisms and supervision of international speculative capital, the issue of ‘fiscal paradises’ (offshore centres), and the necessity of establishing taxes on speculative capital.
e. Relationship between the mechanisms of financial regulation and the World Trade Organisation (WTO).
f. Transparency standards for the operation of these organisations, the influence of developing countries in their boards, their relationship with the UN system and the participation of civil society.
For each one of these points it is possible to recognise important differences among the positions of governments of the Northern countries (principally, the G-7), the representatives of the private sector and the NGOs and civil society organisations of the North. As for the developing countries, the debate has just started. Also, it is clear that developing countries (in our case, those of Latin America) have little influence in these discussions and proposals, although, as we have seen, this topic has a crucial bearing on the lives of hundreds of millions of people who live in the underdeveloped world. This is why the discussion of these issues must start in the developing countries. This is why ALOP (Latin American Association of Promotion Organisations) and Oxfam-America organised a seminar on the new international financial architecture in Lima on 6-8 September 2000.
The above is the edited text of an introductory paper by the authors to a seminar on The New International Financial Architecture and Latin America organised by ALOP (Latin American Association of Promotion Organisations) with the support of OXFAM-America, held in Lima on 6-8 September 2000.
Please note that tables and figures are not included in the web version of this article.
1. ‘From the beginning of Asia’s takeoff until the beginning of 1990, growth in the region was financed, principally, by specific projects, with the immediate payment of debts and the savings of every country. The debt ratio was low. The majority of foreign capital came as foreign direct investment, that is, corporations that built industries, generally for export markets. If there was any speculative fever - and there was - it came later and it does not hinder the reality of previous growth’ (Paul Krugman (1999), The Return of Depression Economics, WW Norton & Company, p. 48). Liberalisation of the capital account in these countries started at the beginning of the 1990s.
2. Joseph Stiglitz, speaking at the Spring Meetings of members of the Institute for International Finance, 25-26 April 1999.
3 Joseph Stiglitz, ‘What I learned from the economic crisis’, The New Republic, April 2000.
4. World Bank, in Barry Eichengreen (1999), Toward a new financial architecture: A practical Post-Asia Agenda, Institute for International Economics, p. 41.
5. Dani Rodrik (1999), The New Global Economy and Developing Countries: Making openness work, Policy Essay #24, Overseas Development Council, Washington, D.C., pp. 89-90.
6. ECLAC (1999), Preliminary balance of the economies of Latin America and the Caribbean, Santiago de Chile, p. 12.
7. Quentin Woodon, editor, Poverty and Policy in Latin America and the Caribbean, draft, 15 February 2000, p. 19.
8. In China, from 1975 to 1995, poverty decreased from 59% to 22%; in Thailand, Indonesia, Malaysia and the Philippines, the numbers were 8 and 1, 64 and 11, 17 and 4, 35 and 25, respectively (World Bank, Social Consequences of the Asian Crisis, 1998). These figures show a wide generalisation of the benefits of economic growth.