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LATIN AMERICA AND THE CARIBBEAN: POLICIES TO IMPROVE LINKAGES WITH THE GLOBAL ECONOMY
Four years ago, the secretariat submitted to the States members of ECLAC the document entitled Changing Production Patterns with Social Equity. It offered general guidelines for the development of the countries of Latin America and the Caribbean, including, in particular, the proposal that production should become more internationally competitive, not only in order to increase exports but also to achieve efficient import substitution. At the same time, the document offered a framework for subsequent activities of the Commission revolving around the study of a number of related topics.*
The economic panorama of the region has indeed changed considerably in these four years. Although with certain differences among countries, the macroeconomic disequilibria of the past decade have begun to be corrected; the transfer of resources out of the region has turned around to become a huge net inflow of foreign capital; the export sector has grown and diversified; and economic activity as a whole has shown a modest recovery. The Latin American and Caribbean countries are now feeling the need to build on these advances, some of which are still rudimentary and partial, surmount the difficulty of making headway in highly competitive international markets and overcome the considerable social lags that have accumulated. Their chance of carrying out all these tasks will ultimately depend on establishing better linkages with the global economy.
One of the many conclusions reached in this document is that, notwithstanding the multiple obstacles that impede development in the region, a constellation of potentially favourable factors is also present today which could give this development a strong boost. These include the gradual assimilation of the lessons learned in the process of increasing and diversifying exports; improvement of the quality of macroeconomic management; the chance to fill a gap in public policy instruments in the region i.e., the implementation of micro- and meso-economic policies in order to increase productivity in accordance with the best international practices; renewed access to external financing; and a boom in intraregional economic cooperation. Another factor has been the recent adoption of new international trade rules under the Uruguay Round. These rules, although far from meeting all the region's demands, at least represent a step forward in support of multilateralism.
Whether improvements can be made in the participation of Latin America and the Caribbean in dynamic trade flows and in the region's access to technology, foreign direct investment and financing depends in part on exogenous factors which are beyond the control of the countries of the region. However, much remains to be done in terms of both national policies and intraregional cooperation ** to enhance linkages with the global economy.
The main purpose of this document is to explore the scope of efforts being made to achieve these objectives. It discusses three interrelated types of policies, namely, trade policy, micro- and meso-economic policy in support of production systems, and macroeconomic policy, with specific emphasis on financial flows. The last one is especially relevant in the current economic environment, in which capital inflows are having a crucial effect on two key variables in the behaviour of exports interest rates and, in particular, exchange rates.
The document is divided into three parts, one for each type of policy. The first chapter of the summary section not only provides an overview of the contents of these three parts, but also combines their various components into an integrated, coherent presentation in the framework of the systemic proposal that has been put forward by the secretariat.
It should be noted that this document, like those preceding it, does not claim to offer universal recipes, in view of the enormous diversity of situations in the region. Rather, it seeks to promote a debate on areas of key interest to the various countries in their efforts to improve their linkages with the global economy, as part of the agenda of changing production patterns with social equity.
SUMMARY AND CONCLUSIONS
A. INTERNATIONAL LINKAGES AND DEVELOPMENT
1. Main features of Latin American and Caribbean linkages with the global economy in the 1990s
1. The linkages between a number of Latin American and Caribbean countries and the international economy have undergone very significant changes in recent years. These include, in particular, the intensification of efforts to export and to liberalize imports, a process that began during the 1980s in several countries and that is becoming more pronounced in the 1990s. For the region as a whole, the volume of merchandise exports increased by an annual average of 5.4% during the 1980s, and by 7% from 1990 to 1994; these figures compare favourably with the 4.7% growth rate recorded for the volume of world trade during that same 14-year period.
2. None the less, the relative buoyancy of the export sector has not always been reflected in the behaviour of the economies as a whole. In the 1980s, gross domestic product increased by only 1.2% a year; from 1990 to 1994, it registered an average annual growth rate of 3.4%. As a result, the export coefficient rose from 14% in 1980 to 21% in 1990 and to 23% in 1994. In other words, the growing importance of the export sector in the region's economies can be attributed in part to the expansion of this sector, and in part to the poor performance of the regional economy as a whole.
3. The reason for this phenomenon is that during the 1980s, in a context of burdensome external debt service and a collapse of the flow of fresh funds to make the necessary economic changes, the countries of the region had to make a recessive adjustment. A good part of this adjustment was based on sharp reductions in the money supply and fiscal expenditure, and on devaluations in the exchange rate for the dual purpose of slowing down imports and promoting the production of exportables. In the first stages marked by high costs of domestic finance and scant improvement in productivity real wage levels, employment and production activity bore the brunt of the adjustment, and this in turn depressed domestic demand.
4. Thus, although export volumes were frequently dynamic, the opposite was true of production and investment for the domestic market, especially in non-tradables at the international level. Consequently, the performance of the economy as a whole, as well as of investment and total output, tended to be rather lackluster despite the growth of exports.
5. A small portion of this growth was the outcome of a still incipient change in production patterns, based on an endogenous process of increases in productivity and encouraged, inter alia, by the gradual elimination of anti-export biases in economic policy. The restructuring process also enhanced the competitiveness of a growing number of firms and increased their capacity to explore and penetrate external markets, with considerable variation among the countries of the region. This change in production patterns gained momentum in the 1990s.
6. Part of the impact of the push for exports was also neutralized by the deterioration of the terms of trade that was caused not only by negative trends in the international markets for the region's exportable supply, but also by insufficient diversification of Latin America and the Caribbean's trade structures in favour of product lines having a more stable, dynamic external demand.
7. Since the beginning of the present decade, and owing to a combination of factors, the outward transfer of financial resources that characterized the 1980s has reversed itself, and private external finance is once again in abundant supply, with annual inflows averaging US$ 61 billion for the period 1992-1994. Net inflows, which mirror the universal changes taking place in international capital markets, have been based on more diversified sources of finance than before. In particular, foreign direct investment and portfolio investment have increased in the form of bonds and equities either directly or as ADRs/GDRs, and foreign investors are increasingly participating in emerging markets. These phenomena indicate that the region is developing new mechanisms to attract external resources, and that the growing importance of foreign direct investment means not only more funds but also technology transfers in support of the processes involved in changing production patterns.
8. In a situation of increased capital inflows, most of the economies have begun to recover in a context of greater price stability. However, their growth tends to be much slower than the trend in export volumes would suggest. One reason for this is the deterioration of prices which fell by an average of 11% just between 1990 and 1994 and the weakness of production linkages between the export sector and the rest of the economy.
9. The reversal of the trend in net external finance from a situation of marked constraint to one of considerable abundance has not been reflected, in general, in investment levels. Available data up to 1993 indicate that gross fixed capital formation stood at over 18% of regional gross domestic product, somewhat higher than the average of 17% in 1983-1990 but much lower than the 24% registered in the five-year period 1976-1980. The growth of the investment coefficient has been significantly slower than the increase in resources from abroad, because part of these resources had to be spent to offset the deterioration of the terms of trade, while another part was used to finance more consumption, especially of imported goods.
10. Because of their high volume, these flows have also had some undesired effects in a number of countries, especially on the exchange rate and money supply, and have increased the countries' vulnerability to external shocks. In some cases, these effects have undermined the objective of promoting the tradables sector of these economies and, as mentioned above, have diverted national saving to the consumption of imported goods.
11. In general, the economic policy adopted by the countries of the region has underlined the need to export more goods and services and to do it better. In a situation where imports are expanding faster than exports, and where there is a growing deficit on current account, the increase in export volume increasingly appears to be a macroeconomic requirement for sustaining the recovery of growth. It would also be useful to strengthen the ties between export sectors and other production sectors, because such linkages lead to intermediate demands for goods, services and labour, quality improvements and absorption of technological progress.
2. The international scenario
12. The international scenario will present new challenges and opportunities for Latin America and the Caribbean in the foreseeable future. Four features of world economic trends in the 1990s stand out: i) slower growth in the industrialized economies in comparison with previous decades, and recession in the transitional economies; ii) stronger trends towards globalization and technological change; iii) realignment of the major markets, with Asia becoming more important in global economic dynamics, and with many developing countries seeking to improve their linkages with international markets; and iv) an impressive expansion of international capital mobility and the creation of mechanisms to facilitate this expansion.
13. One of today's leading trends is globalization, as can be seen from the increase in trade volume compared to global output, the boom in foreign direct investment and the enhanced importance of transnational corporations, the much more flexible, dynamic financial system and the new international organization of production and trade characterized by the importance of subcontracting and intra-industry (and intra-firm) trade. This globalizing trend is not immune to the tensions produced by trade imbalances in the countries of the Organization for Economic Cooperation and Development (OECD), especially the high surpluses in Japan and the deficit in the United States, the persistence of protectionist attitudes and the latent risk that agreements among groups of countries will lead to more closed economic blocs.
14. Technological change, for its part, offers many opportunities and also some risks. In growing economies, it favours the net creation of jobs in the medium term, but may act in the opposite direction in the short term. This risk is higher if global investment is relatively low. It is worth noting that the most important impact of the current technological cycle on employment is the obsolescence of certain skills and know-how. Consequently, some jobs are eliminated and others are created which require new skills that workers who are currently unemployed or those who have been displaced by technical or organizational change do not necessarily have.
15. Notwithstanding the foregoing, the recent signing of the Final Act of the Uruguay Round of GATT, together with the ratification of the North American Free Trade Agreement by Canada, the United States of America and Mexico, constitute (for different reasons) a reaffirmation of multilateralism which is consistent with the globalization process. The adoption of new rules, procedures and institutions to govern contemporary international trade is a promising although still imperfect point of departure for the efforts being made throughout Latin America and the Caribbean to improve the region's linkages with the global economy.
B. POLICY GUIDELINES
16. To make sustainable changes in production patterns with social equity, the economies of the region must improve their linkages with the international economy, i.e., their participation in dynamic flows of trade, foreign direct investment, technology and finance. These linkages should enhance the countries' capacity to take advantage of expansive cycles in international and regional trade and to cope with adverse cycles and financial instability by diversifying products and markets, seeking investment and alliances abroad, applying domestic stabilization mechanisms and improving the coordination of exports with other productive activities.
17. What is required in order to make a quantitative and qualitative improvement in the linkages of the Latin American and Caribbean economies with economic globalization is a simultaneous, coherent effort in a number of policy areas, within the framework of the systemic approach proposed by the ECLAC secretariat. These areas include policies on trade, exchange rates, productive development and finance and, in particular, the interaction among the policies themselves. In other words, for these policies to be effective and efficient, none of the areas can be addressed in isolation from the rest.
18. Indeed, in the absence of a suitable macroeconomic environment, the effects of micro- and meso-economic policies designed to promote the development of the production sector will be weakened. To base such efforts exclusively on trade policies, disregarding the expansion of production and the macroeconomic environment, may, at best, promote export growth, but this may not necessarily invigorate the rest of the economy. On the other hand, limiting export promotion to trade reforms and the preservation of macroeconomic equilibrium may lead to stability but not growth, and still less to the stimulation of endogenous processes of improved productivity and competitiveness.
19. There are, of course, no universally valid paradigms for improving international competitiveness; the experiences of East Asia show that, although there may be a common denominator in the general approach, different paths have been taken in terms of the details of policy implementation, instruments and institutions. With this caveat, the subject areas and proposed policy guidelines contained in this document are presented below.
2. Integrated trade reforms
a) A strategy for enhancing the region's integration with the global economy
20. The modernization of trade policies requires more, of course, than just reducing import restrictions: this is, at best, only a starting point. In addition, a strategy must be developed for improving the region's linkages with international markets, which would then be implemented on the basis of a series of coherent guidelines and measures that would persistently and energetically help promote the production of goods and services with export potential.
21. Tariffs, non-tariff measures and incentives to produce non-traditional exports are core components of any trade policy. Together with the exchange rate, they influence the net incentive to export or to substitute imports. The anti-export biases of this combination of incentives must be eliminated. It would even be advisable to introduce temporary biases in favour of non-traditional exports, which would be consistent with a reasonable degree of transitory protection for other activities; this would create a mix of selective policies geared towards overcoming market shortcomings and taking advantage of clear externalities.
22. One expression of the selectivity referred to above is found in the reformed tariff structures in the region in recent years. Many Latin American and Caribbean countries have drastically reduced their high tariffs and have considerably narrowed the distance between minimum and maximum levels. However, the great majority of them have retained a certain moderate differentiation, with only a few brackets, which is justified on the basis of externalities and deficiencies in factor markets (technology, finance and training) and product markets (economies of scale and dynamic externalities).
23. With regard to the production and sale of exportable goods and services, a bias persists in many cases against the value added in their production, although it is clear that this bias has been significantly reduced. The new tariffs, although they tend to be moderate, are usually above zero, and do not always have an equivalent counterpart in incentives to compensate exporters. In such cases it thus becomes necessary to offset the specific anti-export biases generated by protection. Added to this, in general, is the failure to provide compensation to pioneer exporters for the externalities they generate, even though their activity has all the earmarks of an "infant industry".
24. The first firms to identify a new product which the country can produce efficiently and sell on international markets at competitive prices are real innovators. They become liable to the costs and risks of penetrating a new market; once they have done so, other firms benefit from the innovator's efforts. Pioneer exporters therefore deserve to receive incentives so as to be able to meet the high initial costs of penetrating markets, and should be compensated for the positive externalities they generate for the other firms that imitate them.
25. Promoting the international competitiveness of a country's products and of its non-traditional exports necessarily forms a part of the policy mix aimed at implementing a strategy to change production patterns. Experience shows, however, that incentives both to enhance international competitiveness in domestic activities and to promote non-traditional exports should be circumscribed, should be limited in duration, should depart no more than moderately from a point of neutrality and should do so selectively.
26. The outcome of trade liberalization and its evolution are influenced by each country's structural features, its economic situation and the mix and sequencing of policies. However, opening up an economy to imports does not, per se, guarantee high export and GDP growth rates. There is a clear need for complementary measures which are directly aimed at promoting exports, easing the restructuring of import substitutes and improving systemic competitiveness.
27. It is important to send out clear signals on the significance of investment and innovation in expanding and improving export capacity, and of restructuring and rationalizing the sectors that produce importables. A well-balanced management of the exchange rate, a gradual overall reduction of protection levels, effective export promotion mechanisms and a productive development policy will be crucial elements in achieving this objective.
28. Exchange rate or investment policies should not respond passively to misleading short-term signals, such as a temporary increase in exports resulting from an initial recession or from the elimination of artificial obstacles, or the failure of imports to react immediately to liberalization, also because of a recession or lack of marketing channels.
29. Reform processes in which decisions are shared with private agents are less traumatic, since they make it possible to adjust to the new conditions at the micro-economic and sectoral levels. If trade liberalization is accompanied by consistent macroeconomic policy and credibility in government action, there are better chances of working together to reduce the costs of adjustment.
b) Exchange rate policy and trade reforms
30. Tariff reductions should be accompanied (if not preceded) by a compensatory variation in the real exchange rate. Easing access to imports, associated with an appreciation of the currency (and the use of this policy to stabilize prices), is usually a dangerous combination for the equilibrium of the balance of payments and for productive development.
31. A sine qua non for the success of trade reforms, whether these involve a drastic liberalization or a gradual opening and whether they are integrated or only partial, is to avoid exchange rate appreciation. The experience of a number of Southern Cone countries in the period 1976-1981 illustrates how harmful the dual impact of real exchange rate appreciation and drastic liberalization of imports can be. To enable the Latin American economies to produce tradables, a favourable, stable effective exchange rate must be maintained, i.e., a real exchange rate which, as a reflection of the basket of currencies used in the country's foreign trade, fluctuates on the basis of long-term factors, is relatively independent of temporary economic conditions and is not overly correlated with short-term capital movements.
32. The impact of exchange rate policy on the various sectors is heterogeneous. The greater the diversification and installed capacity of the industry, the more sensitive it will be to exchange rate policy. It has been shown that the elasticity of the manufacturing sector in relation to the level of the exchange rate and equivalent incentives is systematically higher than the elasticity of total exports, in both the long and short terms, and that this sector's velocity of response is also higher, especially in countries where industrial diversification and expansion of production capacity have historically been greater.
33. A number of empirical studies also show that a stable real exchange rate, at a remunerative level for producers of tradable goods and services, is essential to the success of a trade policy geared towards changing production patterns. Exchange rate instability tends to hurt investment, especially in non-traditional exports, since the process of launching products in international markets is usually costly, and investors will not take the risk without being fairly certain that the venture will be profitable.
34. One of the key economic policy challenges in the region, which arose in the early 1990s, is to find a way to maintain trade liberalization together with either the depreciation or stability of the exchange rate in a situation of huge net capital inflows. To do so, countries must not only encourage domestic saving but must also regulate these inflows in order to maintain the real exchange rate at a competitive level in line with the relevant medium-term factors.
35. Most of the recent liberalization experiences in Latin America have taken place in economies whose exchange rates had previously depreciated sharply as a result of the debt crisis of the 1980s and the shortage of external finance. Under current reforms, however, the effects are being produced in a context of a strong real exchange rate appreciation in the 1990s, associated with voluminous flows of external capital, much of which is short-term. Systematic data for 17 Latin American countries indicate that 12 of them have experienced significant revaluations of their real exchange rates during this decade. It is worth repeating, however, that these revaluations occurred following considerable depreciation. With regard to capital movements, it is noteworthy that net inflows in 1992 and 1993 represented a similar proportion of GDP as in the period 1977-1981, and quadrupled the low average of 1983-1989.
36. To sum up, there are no good substitutes for exchange rate stability, especially in economies such as those of Latin America, for which a qualitative improvement in international linkages is a decisive factor in their development strategy. Hence the importance of linking trade policies with those designed to expand production and gain a better international financial position by stimulating domestic saving, fostering a comprehensive development of the country's capital market, reducing its segmentation, and adapting the level and composition of external capital inflows to the domestic capacity to absorb them.
c) Anti-dumping regulations,countervailing measures and safeguard clauses
37. Liberalizing their trade policies and import regimes has made Latin American economies more vulnerable to unfair trade practices and the instability of their trading partners. It is therefore essential that the countries of the region adopt or improve anti-dumping regulations, countervailing measures and safeguard clauses, without, however, allowing private interests to use the new provisions in these areas to introduce undue regional protectionism.
38. Under the Uruguay Round, new international regimes have been adopted in each of these fields. Accordingly, the regulations which countries adopt in this area will have to be compatible with the commitments made. While it is true that the new regimes will determine the kind of mechanisms that the countries of the region can establish, they will also limit the arbitrary treatment sometimes faced by Latin American and Caribbean exports in extraregional markets.
39. The issue of fair competition is becoming increasingly relevant in the context of current regional integration agreements leading to total liberalization of the corresponding markets. It is particularly important that the safeguard mechanisms adopted in Latin America and the Caribbean to avoid exceptional short-term problems should not interfere with the long-term benefits that can be expected from intraregional integration programmes (see ECLAC, 1994a).
40. The adoption of the new regulations emanating from the Uruguay Round could limit the possibilities of implementing an active trade policy in the region, particularly for the promotion of non-traditional exports. However, those regulations do make certain exceptions for the developing countries, and the countries of Latin America and the Caribbean should take advantage of them to promote their exports, while taking care to avoid infringing upon multilaterally-established rules.
41. In this connection, the countries of the region should evaluate carefully the new opportunities for market access afforded by the results of the Uruguay Round, examine the possibilities and restrictions created by the new multilateral regime and rethink many of the issues related to the latitude they enjoy for formulating policies on trade and productive development. For example, such policies must consider their new linkages with the environment and social rights.
42. These observations hold true not only for the action to be taken immediately following the conclusion of the Uruguay Round, but also for future international negotiations, particularly those on free trade agreements with developed nations. They also hold true for making better use of generalized systems of trade preferences, especially in cases such as that of the European Union, which in 1994 will define its new system of preferences for the developing countries.
d) Export-promotion policies
43. The countries of the region should have active export-promotion policies. As mentioned above, the main reasons for implementing such measures are the need to offset the anti-export bias inherent in tariffs, alluded to in earlier paragraphs; the positive externalities generated by export activity; the shortcomings in capital markets for financing exports; and the economies of scale and learning opportunities that exporting provides. Without an active export-promotion policy, exports will tend to be concentrated in products for which demand is less dynamic and more vulnerable in global markets.
44. One basic prerequisite for promoting the competitiveness of export firms is to guarantee them access to inputs on competitive terms. These firms should have access to flexible mechanisms for importing inputs on a temporary basis to produce exportables, once certain basic requirements have been met. Other alternatives are tariff exemptions or drawbacks, with a minimum of red tape. Such mechanisms could also be applied to indirect exporters (domestic producers of inputs for exporters).
45. The governments of the region could support pioneer export firms by providing incentives for exports of new products or for penetrating new markets. One mechanism is a "simplified drawback" for products whose export level is below a given amount for a specific period. These incentives should be moderate (helping to place competitive or near-competitive products in foreign markets), limited in time, and subject to precise results in terms of new products, amounts or markets.
46. The public sector can help improve performance in foreign markets by providing institutional support for export activity, especially in the areas of information, financing and export insurance; management training to encourage businesses to focus on exporting; and promotion of the exportable supply abroad. Pioneering efforts are also being made in such areas as investing abroad to support export activities, marketing chains, joint ventures with firms in target markets and other mechanisms that export-promotion policies are beginning to consider.
47. The development of the exportable supply within the country should also be actively supported, in order to adapt it to the demands of foreign markets. Timely, up-to-date information on the requirements of export markets in terms of quality, environmental regulations, standardization, deadlines and volumes would facilitate this task. It would also be useful to promote ties between domestic firms and international trading companies, particularly in sectors in which the country has export potential. Besides laying the bases for strategic export alliances between domestic and foreign firms, these ties also stimulate steady quality improvement and the development of new products, making domestic firms more flexible in responding to new commercial opportunities.
48. Past export-promotion policies often neglected sectors based on natural resources. Recent technological advances in microelectronics, data processing, telecommunications and satellite technologies considerably augment the supply of information on the quality and volume of economically available natural resources. This is one more reason for acquiring and strengthening comparative advantages in non-traditional natural resources with significant economic rents.
49. To be effective, an export-promotion system must be somewhat selective. It is impossible to promote everything indiscriminately. The selection of sectors, and export-promotion decisions in general, should be made in close, systematic cooperation between the public and private sectors. To this end, exporters' and producers' trade associations should also be strengthened.
50. Many countries have recognized the advantages of consolidating into one institution the various agencies that support non-traditional exports. These agencies should be financially stable and have qualified professional staff, so that they can have more influence on policy decisions affecting exports.
3. Meso- and micro-economic policies for expanding production
51. One of the main concerns of the ECLAC secretariat throughout the past decade has been to enhance international competitiveness by applying technical progress to the production process. The secretariat has emphasized repeatedly the systemic nature of the effort required to close the present gap between the "best international practices" and the average total productivity of factors in the countries of the region.
52. It has also insisted that becoming internationally competitive, either in exports or in efficient import substitution, requires not only suitable macroeconomic and trade policies, but also micro- and meso-economic policies; in other words, the enterprise itself must be modernized (technology, equipment, organization, labour relations), as must its environment (factor markets and infrastructure). The pace of restructuring, and in some cases the very survival of the firm, will depend essentially on the information and human and financial resources at its disposal.
53. The more distorted the factor markets and the greater the uncertainty about the seriousness of the adjustment and liberalization process and the stability of the prevailing key prices, the greater the likelihood that potentially competitive firms will fail, for lack of time and resources, to undertake the restructuring needed to acquire a comparative advantage in the domestic or foreign market.
54. This is why it is important that key markets those for technology, physical capital, human capital and foreign exchange should function at near-optimum levels. Horizontal policies are needed to achieve this, namely policies designed to fill in the main gaps and resolve the main bottlenecks in those markets. The difference between today's policies for expanding production and the "industrial" policies of the past is, precisely, the importance they attach to improving factor markets, with a view to narrowing or eliminating the gap between the average productivity of the region and that obtained using the best international practices.
55. Latecomers to development like the countries of the region have tremendous latent potential for increasing their productivity. Narrowing the gaps mentioned in the preceding paragraph in other words, modernizing demands an active learning and restructuring process in the areas of technology and organization, as well as in quality-control systems and selling on new markets. All of this entails a major investment in time and capital, both physical and human, especially by firms that are lagging technologically. The essence of a modern policy for expanding production is that it facilitates this learning process, as experiences in other parts of the world and even some in the region show (motor vehicles and parts, wood, paper and pulp, for example).
56. Policies for expanding production are designed to reinforce, rather than replace, market forces. Any incentives should also be temporary. An orientation towards international competition promotes a business attitude centred more on productivity than on short-term profitability, seeks levels of output that result in economies of scale (either because there is a large domestic market, because the original orientation was towards exports or because the activity involves the continuous processing of a natural resource that can easily be exported if domestic demand is insufficient) and tends to adopt relatively advanced but tried and tested technologies (technology is mastered, updated and even adapted, as necessary).
57. Building on the ideas put forward in Social Equity and Changing Production Patterns: An Integrated Approach (ECLAC, 1992a), three sets of measures can be proposed, given their special relevance to policies for expanding production in support of international competitiveness. The first set of measures covers technological development policies; the second, manpower training; the third, improvements in long-term capital markets. A practical programme is also suggested for putting the region's entrepreneurs in touch with the best international production practices.
58. The following policy options are proposed for technological innovation and dissemination:
i) Implement domestic competition policies that go beyond mere trade liberalization.
ii)Partially subsidize firms' technological innovation and development activities, whether these are carried out by them directly or in conjunction with research centres, taking into account the positive externalities generated by these activities.
iii)Develop and strengthen systematic monitoring of the technologies and management methods available internationally, and integrate firms into the relevant information networks, bearing in mind that each firm should be able to make the most informed choice possible as to the technology it decides to apply.
iv) Ensure better financing for technological development efforts, paying particular attention to the needs of small and medium-sized firms. Such efforts include the development of prototypes and pilot plants to facilitate the transition from research to application. The sums needed may be relatively small, the main idea being to demonstrate to private banks that this kind of investment can be profitable and to serve as a tool for learning how to evaluate technological risk.
v) Acquaint businessmen and economic agents in general with the most promising experiences in developing and disseminating technology technology centres for each branch of industry, think-tanks, industrial parks, links between universities and business and alternative financing mechanisms in order to increase the impact of these experiences.
vi) Promote strategic alliances between domestic and international firms that are leaders in technology, management, quality and access to the most important markets, by simplifying administrative procedures, improving information and providing tax incentives.
59. With respect to training, which is sorely lacking in the region despite the demonstrably high returns on investment in human capital, and also despite the fact that manpower capacity is a key to productivity, the following measures are proposed:
i) Provide tax and monetary incentives to firms that train their staff, to offset the negative externality that such training creates (training tends to benefit the worker far more than the firm that trains him).
ii) Undertake promotional and publicity measures to accelerate the use of training incentives and to introduce more efficient human resources management practices and more cooperative industrial relations.
iii) Reorganize the supply of training, promoting private sources and concentrating public efforts on bringing instruction, and instructors, closer into line with the production system and its future needs; ensure the quality and relevance of the courses offered, establishing mechanisms for certifying the training given; and promote and finance training opportunities for marginal or unemployed workers or those employed by small firms, who are not usually reached by such programmes.
iv) Promote special basic training programmes for the large segment of the labour force (40%) that have not completed their primary education, and subsidize regular training programmes to help raise the productive potential of this huge group of workers who will be unable to benefit from any educational reforms that are implemented.
60. The lack of a long-term capital market means that the extent to which most firms in the region are equipped, modernized and expanded, depends on their ability to finance themselves, not on their future prospects, and this leads to inefficient allocation of capital. This problem is aggravated during periods of restructuring: the fact that a firm has abundant capital (which may be a reflection of its past success) does not always mean that it has a potential for success in the future, yet firms that have such capital tend to invest it in their own activity. They may even overinvest in obsolete activities, to the detriment of other activities with better chances of being modernized and restructured.
61. Lastly, one specific proposal for narrowing the gap between the productivity of many of the region's firms except for those on the leading edge of their respective branches and that of the developed countries is to implement massive extension programmes, which would co-finance visits to foreign factories where the "best international practices" are to be found.
62. The proposal involves organizing and helping finance visits by managers, engineers, technicians, supervisors, workers and trade unionists, from various production subsectors, to foreign plants where the best practices prevail. These visits would last for a specific period of time, for instance, six weeks. On their return, participants would write a report on the best practices with respect to equipment and technologies, production methods, organization of work, industrial relations, quality control, marketing and other aspects. Each of them would disseminate the results of their visits among other firms and the respective business associations and trade unions. The programme would be open to any sector willing to pay its share, whether it was involved in exporting or in import substitution.
4. Capital movements and macroeconomic policy
a) Economic policy and access to international financial markets
63. In the context of the policies under which trade liberalization was implemented, most governments also applied policies to reduce or eliminate restrictions on international capital movements. This initiative, combined with greater macroeconomic stability, investment opportunities and, particularly, the differential between interest rates in the countries of the region and those in international financial markets, helped to strengthen the trend in these markets towards the resurgence of a significant flow of private external funds. The combined effect of these changes in the international arena and in the region's economies has led to the re-emergence of net capital inflows in the past three years.
64. International capital mobility plays a number of highly significant roles in development. Two of these are notable for their macroeconomic effects: i) the channelling of external savings towards countries with insufficient capital; and ii) the compensatory financing of external shocks, which helps to stabilize domestic spending. In Latin America and the Caribbean, external capital has played a positive role in both of these areas in the 1990s, even though only a small fraction of net inflows have translated into an increase in productive investment.
65. It is clear, then, that the capacity to attract external financial flows does not, in itself, ensure that savings and investment processes will automatically be strengthened. This is because domestic and external financial markets have serious imperfections, which limit their ability to allocate resources efficiently, especially to investment in tradable sectors. In this context, a coherent, sustained economic policy can play a vital role in achieving more dynamic and stable development.
66. Moreover, the soundness of economic policy cannot be evaluated solely on the basis of access to external flows, especially during cycles when international funds are in abundant supply. Above all, it is important to consider the capacity of national authorities to maintain macroeconomic stability and the incentives for economic agents to take decisions based on sustainable medium- and long-term goals. Intervention to manage the effects of capital flows is justified in so far as the latter simultaneously affect two key variables for efficient resource allocation: the real exchange rate in the foreign exchange market, and the real interest rate in the money market.
67. In this regard, it should be recalled that Latin American history has been marked by periods of large-scale capital inflows, followed on a number of occasions by periods of debt crisis. This has sparked a wide-ranging debate on the dynamics of the process of opening up the capital account. Today, it is generally agreed that this process should be implemented sequentially, and that it should occur after other liberalization processes, particularly those affecting trade and the domestic financial market, have been consolidated.
68. With respect to the speed at which the capital account should be liberalized, in order to maintain macroeconomic balances and a stable real exchange rate, the process must be tailored to the economy's capacity to absorb and efficiently allocate external resources. It may be desirable to liberalize the entry of long-term capital first, before facilitating transactions involving short-term financial capital. With respect to capital outflows, priority should be given to trade credits for export promotion, and to direct investment abroad by national firms, which is another way of improving their export platform.
69. Capital-account liberalization in the industrialized countries has been fairly slow and gradual, accelerating only in the past 10 years as capital markets have become globalized. However, it is interesting to note that Spain, Portugal and Ireland introduced certain restrictions on capital movements in 1992 to deter exchange rate instability. Once the objectives of stability were achieved, the restrictions were lifted. This highlights the importance of flexible instruments that, according to circumstances, allow some temporary restrictions to be imposed on capital movements to support efforts towards macroeconomic stability.
70. The economic recovery taking place in a number of countries in the region, based on the removal of external restrictions, is obviously limited by available productive capacity. Some countries have been gradually approaching their production frontier. On the one hand, this creates a need to regulate patterns of aggregate demand so as to avoid renewed bouts of inflation or excessive deficits in the external sector. On the other, it heightens the urgency of boosting investment to sustain GDP growth with increases in productive capacity and in the production of tradables. As the debt crisis is resolved, this is the area on which the macroeconomic policies of the countries of the region will have to focus.
71. Promoting a strategy of changing production patterns with social equity also requires, at the strictly macroeconomic level, efforts to manage aggregate demand and its composition. The instruments available for this purpose are fiscal, monetary and exchange rate policies. In the absence of an active fiscal policy, these instruments are reduced to simultaneously controlling the real interest rate (as a monetary policy instrument to stabilize and control aggregate domestic expenditure) and the real exchange rate (as a trade policy instrument to promote the growth of tradables production and influence the composition of aggregate expenditure).
72. A conflict arises when an interest rate consistent with the objective of curbing inflation and stabilizing economic activity (by sterilizing the monetary effects of accumulating reserves) is higher than the international rate, adjusted for expectations of devaluation, thereby providing an incentive for capital inflows and promoting exchange rate appreciation, which jeopardizes the objective of protecting the economy's tradable sector. Conversely, if real domestic interest rates are allowed to fall, both objectives are thwarted, since the higher expenditure induced by lower interest rates will put pressure on prices and rapidly boost the current account deficit, threatening to cause an unsustainable macroeconomic imbalance. The authorities can resolve this conflict by acting directly or indirectly on capital flows, as some Latin American and Caribbean countries have been doing in the 1990s.
73. One of the main questions faced by the region's governments in designing economic policy concerns the possibility of distinguishing, on the one hand, between domestic and external factors that explain the resurgence of capital movements in the region and, on the other, between short-term capital flows (which tend to be more speculative) and medium- and long-term flows (more closely associated with productive investment). From this viewpoint, it would be desirable for external financing to contribute to the investment process needed to strengthen productive competitiveness, meaning that the entry of long-term capital should be stimulated and that of speculative capital should be discouraged.
74. When the authorities are faced with an unexpected abundance of external financing which they consider to be partly transitory or as flowing too fast for the economy to absorb, they can intervene at three levels. At the first level, they can act to moderate this inflow's impact on the exchange rate through the purchase of foreign exchange (i.e., the accumulation of reserves) by the central bank. At the second level, they can adopt sterilization policies to mitigate the monetary impact of the accumulation of reserves at the first level of intervention. At the third level, they can adopt policies on incentives, surcharges or quantitative controls to regulate inflows of capital, thereby influencing the latter's composition and volume, the aim being to encourage flows whose volume is compatible with the economy's domestic absorptive capacity, channelling them into productive investment projects, and, conversely, to discourage the entry of short-term speculative capital. These measures are more effective when they are coupled with strict prudential supervision of the financial system.
75. In sum, governments have two options. Some have adopted so-called non-sterilized intervention, meaning that they intervene at the first level by having the central bank buy foreign exchange, without sterilizing the resulting monetary effect. If the authorities choose this option while also liberalizing capital movements and maintaining a nominal exchange rate with a predetermined rate of variation, they may tend to lose control over monetary aggregates. The other option is the so-called sterilized intervention, which broadens the scope of the first option by offsetting the monetary impact of the accumulation of reserves with active operations to regulate the money supply. This is intended to keep the real exchange rate within desirable limits according to medium- and long-term objectives.
76. The sterilization option entails certain costs, since the interest rates which the central bank must pay on its notes are higher than those it obtains on its placements in foreign currency. These costs are not necessarily permanent if the central bank maintains a real exchange rate, pegged to a currency basket reflecting the composition of the country's external trade, that is sustainable in the medium term. The bank can facilitate its task, and reduce its costs or even turn them into profits, by adopting a policy of "dirty" floating within an exchange rate band: it can earn profits by buying and selling foreign exchange, thereby offsetting losses attributable to the interest rate differential.
77. Since most countries in the region have at some point opted for sterilized intervention, they have faced serious conflicts between exchange rate and monetary management. To moderate such conflicts, they have used complementary measures, such as providing for a degree of flexibility in fiscal policy to regulate aggregate demand; stabilization funds for the main export products to soften shocks in their price cycles (as in the case of Chilean copper and Colombian coffee); and income policies to adapt the relative prices of factors to changes in productivity.
78. As mentioned earlier, when fiscal policy has no instruments through which it can act flexibly, monetary policy (interest rates) and exchange rate policy (exchange rates) are the only means of controlling aggregate demand. To resolve the conflict that may arise in the simultaneous management of these two variables, the authorities have the option of intervening at the third level with measures intended to change the volume and composition of capital flows, giving priority to long-term flows through incentives (reserve requirements or taxes, and exchange rate measures that generate more uncertainty for short-term capital flows) or even via quantitative controls.
79. Direct quantitative controls include requirements as to minimum maturity periods, minimum volumes for bond issues, ceilings on external borrowing by financial institutions, and regulations on the participation of foreign capital in the stock market.
80. In the current circumstances of abundant external funds and comparatively low international interest rates, third-level intervention policies and sterilization measures act on monetary aggregates to prevent excess expenditure (especially private spending), forestalling artificial, temporary increases in domestic spending which could cause severe declines in national savings and excessive increases in external liabilities, without a corresponding increase in the capacity to produce tradables.
b) Improvement of domestic financial markets
81. The extent to which flows of foreign capital can further a strategy of changing production patterns with social equity largely depends on the characteristics of domestic financial markets. This observation is based on the experience of the external debt crisis, which resulted from large-scale inflows of bank credit. On that occasion, capital markets were unable to avoid generating "financial bubbles", adverse selection and moral hazards, features inherent in financial markets.
82. The challenges involved in the prudential regulation and supervision of domestic financial markets become apparent when consideration is given to the speed with which external funds can flow into those markets. Unless financial institutions and instruments including public regulatory and supervisory institutions themselves are actively developed, the intermediation of these funds by fast-growing financial systems could cause distortions and macroeconomic instability by channelling them into high-risk credits ("credit bubbles"), sharp increases in the prices of existing shares ("stock market bubbles") and steeply rising prices for real estate and other assets.
83. As suggested in the comments on policies for productive development, the reorganization of financial systems, including the liberalization of capital movements, should give priority to channelling resources into savings and investment, in close coordination with the development of productive capacity. This role has not been sufficiently emphasized in the region's financial reforms. The relationship between the financial system and national savings and investment processes, and between that system and external financial markets, must be considered more carefully.
84. As regards the relationship between financial markets and capital formation for development, an institutional framework is needed to complete or perfect markets according to three criteria. First, it must include a dynamic long-term segment of the financial market in order to finance productive projects. This involves discouraging speculative segments and concentrating on long-term international capital accompanied by access to technology and to export markets. The impact of capital entering the region through foreign direct investment is important in this context.
85. Second, it must promote access to financing for small and medium-sized firms hurt by the segmentation of the capital market. To that end, this market must operate with some selective criteria that target the training, development promotion and modernization needs of small production enterprises. Credit institutions and guarantee mechanisms are needed to do what the region's capital markets have failed to do spontaneously. The aim is not to subsidize the cost of credit, but to promote access to financing at normal interest rates, as well as the access to technology, inputs and services, marketing channels, long-term financing and infrastructure that will enhance the productive capacity of these sectors.
86. Third, it must recognize that, in countries with "emerging" stock markets, financial liberalization of the capital account by opening it to international portfolio investment runs the risk of creating external over-indebtedness and excessive stock market and exchange rate fluctuations. Large-scale inflows of foreign capital to domestic markets can trigger both "stock market bubbles" and exchange rate appreciations at the same time. The subsequent decline in stock market levels can, in turn, cause capital outflows and upward pressure on the exchange rate. This means that financial institutions operating in capital markets must be regulated and supervised to ensure their stability.
87. Prudential financial regulation can counter these risks and contribute to an orderly, stable process of attracting portfolio investments from abroad. To that end, as noted earlier, financial regulations can act on two key financial variables interest rates and exchange rates by establishing bands for these values, or certain rules governing their behaviour. These variables can also be influenced indirectly by means of regulations affecting the availability or cost of funds, including certain restrictions on access, reserve requirements and taxes. The norms governing a country's capital inflows and outflows, whether of foreign or national funds, are part of these regulations. In order to design such norms, the relevant institutions need to have statistical information on external flows (types of flows, volumes, costs and sources) and on the accumulation of stocks of external liabilities in the national financial market.
88. Prudential regulation focuses mainly on ensuring the solvency of the banks, financial funds, insurance companies and other agents that manage resources or assume third-party risks on a large scale. Since the performance of these functions relies on public confidence, the solvency or stability of financial institutions entails significant macroeconomic externalities.
* Thus, for example, the link between changing production patterns, social equity and the environment was addressed in 1991; in 1992, the existing reciprocal ties between changing production patterns and social equity were examined in further depth; and in 1993, the topic of population was incorporated into this framework. The references for these documents are contained in the bibliography.
** The potential for economic integration is the subject of a separate but complementary document. See ECLAC, Open regionalism in Latin America and the Caribbean. Economic integration as a contribution to changing production patterns with social equity (LC/G.1801/Rev.1-P), Santiago, Chile, 1994. United Nations publication, Sales No. E.94.II.G.3.