What is behind Latin America's Good Performance
The optimism may be shared, but there is no consensus on the primary cause for Latin America’s good macroeconomic performance. Did it lie within the region, its newly found economic resilience the result of its own prudent fiscal and monetary policies? Or was it external, the result of timely multilateral liquidity injections from the International Monetary Fund (IMF) or the emergence of China as a source of both financial resources and demand? There is not enough evidence yet to determine the quantitative impact of each of these possibilities, but certainly the region benefited from both external mitigating factors and internal resilience. There is in this a place for the pride of some policy makers in the region, but at the same time a warning for them about hubris.
The importance of the IMF’s efforts has already been subject to some testing. Izquierdo and Talvi (2010) regressed EMBI spreads5 against an indicator of whether countries had access to the IMF as lender of last resort, and conclude that the IMF did significantly mitigate financial risk.
The other external factor is China. The Asian country fared well throughout the crisis – real GDP growing 8.7% in 2009 – and its sustained demand for commodities served as an important buffer to the drop in global trade. Figure 0.4 shows the strong link between the size of external trade shocks and economic performance. The horizontal axis measures 2009 GDP growth under a counterfactual scenario where all demand components of GDP grew at the average rate during the four years previous to the crisis with the exception of exports which are assigned their actual value. In other words, the horizontal axis illustrates changes in economic growth induced solely by changes in export demand (assuming no Keynesian multipliers on the one hand, nor neoclassical factor flexibility on the other). It can be seen that Mexico, with exports targeted towards battered consumers in the United States, is far to the left in the graph as a result of a significantly larger trade shock in 2009 than countries such as Brazil, Chile and Peru that had diversified their exports towards China.
Figure 0.4. Shock to exports and GDP slowdown (2009)
But deviations from a straight increasing line in Figure 0.4 indicate that external trade factors do not tell the whole story behind Latin America’s different responses to the crisis. Internal resilience, the product of responsible domestic policy, explains another part of countries’ differing responses. The importance of this resilience is most discernible when analysing the financial transmission of the crisis, as countries with poor policy fundamentals quickly lose the trust of foreign investors. The disruptive capital flows which follow can exacerbate and prolong the direct effects of a crisis.
Figure 0.5. Net purchase of domestic assets by foreign investors
Figure 0.5 illustrates a significant mechanism of transmission of global crises, from global savings to investment in Latin America. The bars in Figure 0.5 represent net purchases of domestic assets by foreign investors in each of seven Latin American countries (measured in constant dollars and normalised for each country to the highest level experienced by it during the 1990s).6 The effect of the debt crisis of the 1980s can be seen at once. This kept most of the region below the radar of foreign investors until about 1992. But from then on net purchases track the line for world savings, suggesting a clear channel of financial transmission into the region. The link is also significant at the level of certain individual economies, with correlation between world savings and net asset purchases greater than 0.7 in each of Chile, Colombia and Brazil.
The collapse of global savings in 2009 thus potentially created significant downward pressure on foreign investors’ net purchases in Latin America, and they certainly turned negative in all countries during the last quarter of 2008. But Latin American countries then bounced back, with purchases returning to pre-crisis levels in most countries over the three subsequent quarters. The horizontal axis in Figure 0.6 shows cumulative purchases between the last quarter of 2008 and the third quarter of 2009 in a scaled way (see the note to the figure). There is significant heterogeneity across countries, implying that the responses of foreign investors were as differentiated as those in the trade channel examined above.
The vertical axis in the figure is the part of GDP growth unexplained by the counterfactual scenario considered in Figure 0.4 (that is, the difference between the two co-ordinates in Figure 0.4). What Figure 0.6 shows is that financial transmission explains a large share of this residual: those countries which foreigners continued to favour with purchases of domestic liabilities coincide with those where a larger share of positive growth is left unexplained by trade shocks.
Figure 0.6 shows that the response of foreign investors during the crisis was highly correlated with GDP growth – Venezuela being the only country with significant losses still left unexplained. But is this relation causal? Liability purchases constitute external, although not exogenous, decisions made by foreign investors. In other words, variation of investor behaviour observed in the horizontal axis is not driven only by exogenous external factors, but also endogenous domestic circumstances. China’s role is less relevant explaining this heterogeneity, even though foreign investors are likely to take a more favourable view of countries which, thanks to China, have a more secure stream of export revenues than those which do not. Far more significant to investor response is internal macroeconomic stability associated with domestic policy resilience at the outset of the crisis.
Figure 0.6. Foreign investors’ net purchases and “unexplained” GDP growth (2009)
The concept of policy resilience, and how to measure it, was discussed in last year’s Outlook (OECD, 2009a), where we introduced the "Policy-Resilience Index": that included a composite measure of factors that enlarge policy space on both the fiscal and monetary fronts.7 Figure 0.7 plots such an index for selected countries against the net purchase figures from Figure 0.6.The observed positive correlation highlights the strong link between internal resilience and net domestic purchases by foreign investors.