I would like to thank Chairman Bayh and Ranking Member Hagel for holding this hearing to discuss U.S. economic policy toward Latin America and the role of the international financial institutions.
Strengthening U.S. ties and raising economic growth in the many countries of Latin America are central to President Bush's agenda, not only because we want to help our neighbors, but because their stability is in our interest. The United States benefits directly from having strong neighbors and reaps tangible economic gains when the region fares well. But we risk losses when Latin America undergoes economic turmoil - not least because of the increasing integration within the hemisphere.
When I testified before this committee last February, economic and financial conditions throughout much of Latin America, with the exception of Argentina, appeared to be picking up after the slow growth last year associated with the recession in the United States and the global slowdown. However, since then, conditions throughout the region became more difficult, and economic growth this year is likely to be zero at best. This is in contrast to other developing and emerging market regions where growth is positive this year - about 6% in Asia, 3% in Eastern Europe, and 3% in Africa. Clearly raising economic growth in the region must remain a high priority.
An Economically Diverse Region
Considering Latin America as a single entity overlooks its diversity - from extremely poor nations confronting difficult development challenges to economies with sophisticated financial markets. Some countries in Latin America are performing well economically; they have implemented good economic policies. Others are just beginning to implement good policies, and have much to look forward to. Still others have recently experienced crises or are potentially in danger.
Mexico and Chile's strong economic policies and sound political foundations have set them apart in the region. Chile remains ranked among the most open, competitive, and economically stable countries in Latin America - factors that help to explain its average annual growth rate of 6.8% throughout the 1990s, a figure well above the regional average of 3.3%. After experiencing high inflation (70% annual average) and near-zero growth throughout the 1980s, Mexico's economy grew by an average of 5% per year between 1996-2000 after its leaders had begun to implement a series of key free market reforms - including the North American Free Trade Agreement.
A number of countries are striving to implement strong economic policies, but still have a way to go to realize their full economic potential. El Salvador stands out among those that have made tremendous strides by pursuing sound policies, while Bolivia, Colombia, and Peru are also working hard to implement a strong policy mix that will enhance stability.
Other countries have experienced significant turbulence in recent months despite policy fundamentals that have generally been strong. The United States is closely watching Brazil and strongly supported IMF assistance in August because its economic policies have been strong. Events in neighboring Argentina contributed to significant difficulties in Uruguay this summer, but the Uruguayan authorities have responded strongly in cooperation with the international community.
Finally, Argentina is beginning to stabilize though it remains in crisis following significant deterioration in 2000 that culminated in late 2001 with a freeze on bank deposits, an end to dollar-peso convertibility, and a default on its debt. Argentina and the IMF are working to conclude an agreement in the near future that will help Argentina to strengthen its monetary and fiscal framework.
In the wake of Argentina's crisis, the experiences of different Latin American economies and other emerging markets have been instructive. In the months after Argentina's collapse, we saw little impact on other emerging market countries, even in Latin America. This stands in contrast to the effects of Russia's crisis in 1998, which was accompanied by immediate and sharp rises in the borrowing spreads for other emerging markets, even those that had few real links to Russia. It seems that in recent years investors have become more skilled at differentiating between countries and markets based on fundamental economic assessments. We have sought to promote a further evolution in this direction by emphasizing that policy decisions will not be based on unfounded claims of contagion. We have, however, supported programs where there was direct or fundamental interdependence between countries - as in the case of the effect of Argentina on Uruguay - in order to mitigate such effects.
Improving Prospects for Productivity Growth
Raising living standards and expanding support for democratic institutions in Latin America depend critically on achieving higher levels of economic growth - a key concern in a region where one-third of the people live on less than two dollars per day. The United States is working to help create an environment where the private sector can be the engine for productivity growth.
Productivity merits special emphasis because only by raising productivity - the amount of goods and services that a worker produces per unit of time with the skills and tools available - can countries raise per capita income. And the higher the rate of productivity growth, the faster poverty will decline. Simply put, the ticket out of poverty is higher productivity jobs.
Long-term trends in productivity growth have shown improvements in Latin America in the 1990s. According to the Inter-American Development Bank (IDB), the 1990s had higher productivity growth than the 1980s, reflecting economic reforms especially in the macroeconomic areas. Productivity growth was 0.7 percent per year in Latin America in the 1990s after averaging less than zero in the 1980s.
However, I am optimistic that productivity growth in Latin America could improve by a much greater amount. While productivity growth was 0.7 percent in Latin America in the 1990s, it was 1.7 percent in the developed countries and 2.7 percent in the East Asian countries. That 1 percent or 2 percent productivity difference would make a huge difference in living standards over time.
The first step to raising productivity growth is gaining an understanding of why productivity is so low. Productivity depends on two things: capital per worker and the level of technology. If there are no impediments to the flow and accumulation of capital and technology, then countries or areas that are behind in productivity should have a higher productivity growth rate. More and more evidence has been accumulating that there are significant impediments to investment and the adoption of technology that are holding countries and people back.
The United States is seeking to reduce these impediments to higher productivity growth by emphasizing the need for policy steps in three areas. As identified by President Bush these three areas are: ruling justly, investing in people, and encouraging economic freedom.
First, poor governance, the lack of rule of law or enforceable contracts, and the prevalence of corruption create disincentives to invest, to start up new firms, and to expand existing firms with high-productivity jobs. This has a negative impact on capital formation and entrepreneurial activity.
Second, weak education systems impede the development of human capital. Workers without adequate education do not have the skills to take on high-productivity jobs or to adopt new technologies to increase the productivity of the jobs they do have. There is wide agreement that better education is key to productivity growth. Although the labor force in Latin America grew at similar rates as East Asia in the 1990s, the rate of educational improvement was slower during the past decade. There are of course important educational success stories. For example, in Brazil the Bolsa Escola program, which provides funds to families with low incomes whose children attend school, has led to higher enrollments.
Third, too many restrictions on economic transactions prevent people from trading goods and services or adopting new technologies. Lack of openness to trade, state monopolies, and excessive regulation are all examples of restrictions that reduce incentives for innovation and investment needed to boost productivity. For example, in Latin America on average it takes 12 legal and government administrative steps to start up a business. In Canada it takes 2 steps to start up a business; in the United States it takes 4 steps.
Raising productivity rates involves steps to foster a stable macroeconomic environment, boost the skills of individual workers, and introduce market forces to help channel resources most effectively. In promoting these policies, however, we must remind ourselves that there is no shortcut to sustained economic growth and that good results require a patient commitment over a long period of time.
Achieving U.S. Policy Objectives
The United States is seeking to encourage increases in economic growth in Latin America through an array of concrete policy steps at the bilateral, regional, and multilateral levels.
President Bush signaled the U.S. commitment to bilateral efforts earlier this year when he proposed a dramatic increase in foreign aid through the Millennium Challenge Account initiative. Beginning in 2004, increased assistance will be available to strong performing countries - those that govern justly, invest in their own people, and create a favorable climate for private enterprise - with the total increase reaching $5 billion per year starting in 2006. These funds provide a powerful incentive for countries to create an environment conducive to growth.
The United States has also launched several country-specific initiatives, such as reform of the North American Development Bank (NADBank). President Bush has long recognized the need for serious reform of this instiution. He and President Fox, who had also proposed reforms, decided to do something about the problem. The United States and Mexico established NADBank in 1993 for the purpose of helping border communities cope with the environmental pressures relating to the North American Free Trade Agreement in the U.S.-Mexico border region. But during its seven years of operation, the overall performance of NADBank was unsatisfactory. NADBank had approved only $23.5 million and disbursed only $11 million in loans to projects, despite having $405 million in authorized paid-in capital and a total lending capacity of $2.7 billion. We have made much progress in the reform effort. In order to better use the authorized funds at NADBank, the reforms called for increasing the amount of support from grants and low interest rate loans, allowing NADBank projects to go deeper into Mexico, merging the boards of NADBank and its project-certification sister institution the Border Environmental Cooperation Commission, and allowing retained earnings to fund supply-side water conservation projects on both sides of the border. The reforms were negotiated last spring and summer. The needed legislation has passed the House and is pending in the Senate.
Another example of an initiative with Mexico is the Partnership for Prosperity - an initiative aimed at strengthening Mexico's economy through a number of measures to improve access to capital, build capacity, and stimulate private investment in areas that do not yet fully benefit from NAFTA.
One key area that could greatly facilitate the flow of capital to Latin American countries involves reducing the cost of remittances sent from abroad. The Inter-American Development Bank estimates that Latin Americans living in the United States send an average of $200 to their native countries an average of seven to eight times per year. These remittances surpassed $23 billion last year - about one fifth of total worldwide remittances - and represent an enormous resource transfer to families and businesses that can make direct use of the funds. Although remittance charges are declining, they still range from 6-15% of the remitted amount plus an exchange margin that ranges from 3-5%. Increased competition as more and more traditional financial institutions offer remittance products should help to lower costs.
Trade has enormous significance for spurring productivity gains and growth in the region. With approval of Trade Promotion Authority, we are strongly committed to rapid progress in reducing trade and investment barriers throughout the hemisphere. The Doha agenda of global trade talks will give particular emphasis to promoting development. At the same time, the United States expects to sign a free trade agreement with Chile soon, will continue to work towards completion of the Free Trade Area of the Americas by 2005 as co-chair of the process with Brazil, and has announced the U.S. intention to begin negotiating a free trade agreement with Central American countries starting the first of this coming year.
The International Financial Institutions
At the World Bank and Inter-American Development Bank, the United States is supporting development projects and programs that address the basic causes of low productivity, including projects to raise health and education levels, increase access to clean water and sanitation, and improve the climate for private sector development. A key element of this strategy has been the successful U.S.-led effort to have the International Development Association (IDA) expand the amount of grant financing it provides to poorer countries in order to boost development prospects without adding to country debt burdens. We will also continue our efforts to have the multilateral development banks make operational a system to better measure, monitor and manage for development results. Measuring development results figures prominently in the most recent IDA round in that the agreement's contribution structure allows donors to increase their funding levels if concrete measurable results are achieved. We are convinced that donors and developing countries will benefit from routinely quantifying development achievements and understanding the reasons for success and failure.
Within the IMF, the United States is working to strengthen mechanisms to detect potential crises early and act preemptively to address sources of vulnerability. We are also working to ensure that the IMF is effective in situations when a financial crisis develops. The IMF is most effective when it focuses on the areas central its expertise: monetary, fiscal, exchange rate, financial sector, and debt management policies. At the same time, we are working to increase discipline in terms of access to IMF resources to reduce the size of IMF packages and thereby reduce the risk of moral hazard - i.e., the belief that in a crisis, large-scale IMF assistance will protect investors from the consequences of their decisions. We have also refrained from providing longer-term bilateral loan assistance in crisis cases, as was done in the past. Emphasizing that the IMF must be the key source of emergency support and avoiding recourse to bilateral assistance allows the availability of IMF resources to act as a natural constraint on the size of official financing packages.
We have taken into account a number of considerations to assess when and whether the international financial institutions should provide support to countries, particularly in light of crises and other challenges in Latin America.
First, and most important, countries must be committed to implementing credible and sustainable economic policies. Such policies should embrace a number of principles: strong or improving fiscal accounts, incentives for private sector investment in order to promote growth, steps to strengthen financial systems, and sound monetary and exchange rate policies. Not all actions can be accomplished immediately, of course, but it is important to begin the process as a means of putting economies back onto a sustainable path, as a signal of the authorities' intentions, and as a first step toward re-establishing confidence.
Second, experience has shown that lending programs that lack strong ownership by a country's leaders are likely to fail; we should not support such programs. Narrowing the range of conditionality to critical issues helps increase country ownership over effective programs. And, in the context of crisis lending, providing official sector support to countries with strong ownership over high quality economic programs that promote economic growth is the best way to ensure that official sector interventions in time of crisis are laying the basis for a return to economic health over the long term.
Third, it is important for the IMF and other institutions to structure international financial and development packages properly so that strong incentives for good policy performance are maintained. Prior actions that must be completed before a lending program begins, for instance, can sometimes be a useful means for a country to demonstrate its commitment before international funds are disbursed. "Backloading" financial assistance, with smaller amounts of money provided initially and larger amounts provided later on, can help to ensure that a country's performance does not weaken over time. Lending conditions within a program should also be carefully targeted, focused on those issues that contributed to a crisis and addressing steps that are most essential for future success. Not every crisis results from a fiscal deficit, for instance, and so not every program should automatically require fiscal retrenchment.
Argentina, Brazil, and Uruguay
Let me now provide an update on three of the key countries in the region that have received particular attention in recent months - Argentina, Brazil, and Uruguay.
Argentina has not yet reached a new agreement on an IMF program, but has recently made progress in developing a short-term program to restore monetary stability. We hope that an agreement will be reached soon. Bush Administration officials, including Secretary O'Neill, have stated on numerous occasions both privately and publicly that we want Argentina to succeed. The U.S. has strongly supported efforts to provide Argentina breathing room as it works with the IMF to develop a sustainable economic plan. For example, the United States has backed four extensions this year of repayments to the IMF (totaling about $4.9 billion) and has also worked to accelerate lending from the World Bank and Inter-American Development Bank.
But finalizing an agreement between the IMF and Argentine Government has not happened quickly. The extensive economic problems Argentina has confronted - a dramatic reduction in output, debt default, extensive deposit and foreign exchange restrictions, provincial government deficits, and a sharp depreciation of the exchange rate - have required a significant amount of time and attention. Given the importance of Argentina's economy to the region and Argentina's need to get back on an economically sustainable path, we believe it is essential that Argentina's monetary and fiscal framework be strengthened as a basis for a new lending program. Encouragingly, in recent weeks, there have been some signs that parts of Argentina's economy have stabilized.
For Brazil, we strongly supported the August decision to provide an expanded IMF lending package given confidence in the current policy mix and the firm belief that the short term liquidity pressures facing Brazil can be alleviated through continuing such policies. Furthermore, the design of the program "backloaded" the large majority of IMF resources so that much of the financing will be provided only if sound policies are maintained. The key policy conditionality underlying the program includes maintenance of fiscal prudence and concrete steps to reform major impediments to growth such as the current tax code. Comments by presidential candidates in recent weeks reaffirming support for the main pillars of the program increase the chances of its success.
In Uruguay, the United States supported a $3.8 billion official sector package, and drew on the Exchange Stabilization Fund to provide a short-term bridge loan until IFI financing could be put in place. We did so because Uruguay had a strong record of sound policies and we were convinced that the Uruguayan Government had a strategy to address its difficulties - particularly in the banking sector - and was committed to implementing that strategy.
While we do not yet know the final outcome, initial results in Uruguay have been encouraging. Since the IMF program was announced, we have seen increased stability in the financial system and continued strong performance by Uruguay. Under the IMF program, net deposits in the non-intervened banks have increased. As a result of this improvement in financial sector confidence, only one-third of the $1.5 billion in IMF resources targeted for the financial sector has been used. Uruguay still faces a difficult regional economic environment, but its leaders have shown their willingness to commit to necessary reforms and long-term economic goals.
Outlook for the Region
In spite of recent turbulence, I remain confident about the region's prospects. First, the current economic cycle of slow or negative growth will improve, especially as the U.S. economy continues to gain strength. At roughly 38% of GDP, exports comprise a large percentage of income for the Latin America region as a whole.
I believe that many countries within the region have made important progress over the past decade in strengthening the economic institutions and policies that will improve their growth prospects. In a number of countries, for instance, central banks have focused more on keeping inflation low. And many countries have abandoned soft exchange rate pegs and maintained floating exchange rate regimes, helping them to adjust more easily when faced with economic shocks. Others, such as El Salvador, have been successful with full dollarization.
Across the region, the private sector now contributes a larger percentage of GDP than it did during the 1980s, which will help Latin American economies regain their dynamism more quickly. Many countries now have more extensive trade and financial linkages amongst themselves and with developed economies - such as the United States and Europe - than they did in the past. This is a factor that will help to accelerate their recovery once conditions improve. Finally, Latin America also has a strong human capital and resource base that provides a solid underlying foundation for future growth.
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