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Several European countries face challenges reminiscent of those faced by the emerging economies of Latin America. The economic booms in some peripheral Euro-zone countries financed by large capital inflows; the credit and asset price booms and then the busts including Sudden Stops in capital flows; the strong interaction between sovereign debt and domestic banking systems; the role of foreign banks and contagion; and all in the context of a fixed exchange rate, are familiar plotlines for Latin American audiences. For those Euro-zone countries that built up large Euro-denominated external liabilities, Latin America's experience is particularly relevant and worrisome. Still, Europe may be in a better position to navigate a path out of the crisis given cooperative mechanisms that were absent in Latin America, particularly the availability of massive liquidity support. Nonetheless, while such support buys time, it does not guarantee success. This paper argues that reflecting on Latin America's experience provides useful lessons for Europe to improve the chances for a successful resolution.

Why should people--and economies--save? The typical answer usually focuses on the need to protect against future shocks, to smooth consumption during hard times, in short, to save for the proverbial rainy day. This book approaches the question from a slightly different angle. While saving to survive the bad times is important, saving to thrive in the good times is what really counts. People must save so they can invest in their own and their children's health and education, live productive fulfilling lives, and end their days in comfort and peace. Firms must save so they can grow productive enterprises that employ more workers in better jobs to produce quality goods for domestic and international markets. Governments must save to build bridges, highways, and airports that support a productive economy, to provide quality services such as education, health, water, and sanitation to their citizens, and to assure their senior citizens a dignified, worry-free retirement. In short, countries must save for a sunny day -a time when everyone can bask in the benefits of growth, prosperity, and well-being.

This paper combines development accounting exercises with economic theory to assess the importance of total factor productivity and the accumulation of factors of production as engines of growth in Latin America. Using the new, drastically revised Penn World Table (PWT) and Barro-Lee datasets, the paper shows that lower and non-convergent income relative to successful development benchmarks are explained by subpar productivity gains rather than slower factor accumulation. The empirical analysis of the interplay between productivity and accumulation in the process of development suggests that one explanation for this pattern is that investment in Latin America is not as productivity-enhancing as in less distorted economies.

An analysis of the performance of the global financial safety net during the 2008-2009 crisis, and an evaluation of its new components, indicates that, from an emerging markets perspective, the net remains full of holes despite recent stitches. This paper therefore proposes an effective and workable international lender of last resort (ILLR) for systemic liquidity crises based on: i) an automatic trigger to access the facility; ii) unilateral country pre-qualification to the facility during Article IV consultations; and iii) liquidity funded by the world's "issuers of last resort". These principles would support a reliable and broad-based ILLR without the carrying costs associated with inefficient reserve hoarding, which would actually work as an effective preventive facility with minimal room for moral hazard.

I. INTRODUCTION The current financial crisis has been the most severe and widespread that the international economy has experienced since the Great Depression of the 1930s. Although it originated in the United States, the crisis spread internationally very quickly. Developing countries in particular were affected through various channels, both financial and real. The financial channels include sharp contractions in domestic asset prices and capital outflows, while the real channels include reductions in export volumes, declines in the prices of primary commodities, and reduced flows of workers' remittances. The worldwide nature of the crisis has generated a debate both in each affected nation and in all the major international financial organizations about the appropriate nature of the policy response. The complicating factors in addressing this issue are that the crisis manifested itself in different forms in different countries, that the effectiveness of the policy instruments available to confront it is likely to differ country by country, that each country faces country-specific constraints and tradeoffs in deploying such policy instruments, and that countries differ in the weights that they place on different policy objectives. Not surprisingly, therefore, there has been much international disagreement about appropriate policy responses, and individual countries have implemented quite different policies. This article considers the challenge of crisis policy from the perspective of Latin America, Its particular concern is with the appropriate role for countercyclical fiscal policy in response to the crisis. This issue was hotly debated within the region in the early stages of the crisis, and prominent voices argued for fiscal restraint, for reasons similar to those used to justify fiscal restraint more recently in many countries outside the region--that is, to safeguard market confidence. In the event, breaking with the past, countries in Latin America indeed undertook moderate fiscal stimulus. Instead of engineering fiscal restraint, fiscal balances in 2009 were allowed to accommodate the downturn in almost every country in the region. (1) In the typical country, the primary fiscal balance in 2009 deteriorated with respect to 2008 by 2.4 points of gross domestic product (GDP), 1.4 points because of lower fiscal revenues, and 1 point on account of higher expenditures. Countercyclical fiscal policy was behind not only spending expansion but, in part, revenue contraction because of lowering taxes. This impulse is planned to continue to some extent over 2010. Recovery is currently under way in Latin America. Because there were other forces driving that recovery, however (such as fast-growing demand for the region's primary products from booming economies in Asia), the contribution of fiscal stimulus to the region's recovery remains to be established. However, the question remains: was countercyclical fiscal policy an ex ante mistake that proved to be less harmful ex post because of fortunate developments in trade with Asia? Or have at least some economies in the region evolved to the point where a countercyclical fiscal stance--which indeed represents a significant break from the region's past--was appropriate ex ante in light of the severity of the crisis? The question is an important one, because it speaks to the crucial issue of whether, after two decades of reform, the region's macroeconomic institutions and circumstances have placed it in a position to be able to actively pursue macroeconomic stability in response to external shocks, rather than exercise restraint for the sake of preserving market confidence. In the event that the current recovery turns out not to be sustained or that an independent new crisis appears on the horizon in the near future, the formulation of an appropriate policy response requires that this question be addressed. Because theory suggests that the answer is likely to depend on country-specific conditions, we illustrate some of the important factors to be considered by focusing on the case of the seven largest economies in the region (the Latin American and Caribbean [LAC]-7 countries, consisting of Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela). …

Since the pioneering work of Solow (1957), technological change has been credited with explaining a substantial share of economic growth. Indeed, recent evidence for the United States shows that investments in R&D—a proxy for the innovation effort of a nation—made up 40 percent of the productivity growth observed during the postwar era (Reikard, 2011). Based on these findings, several Latin American and Caribbean countries have established and implemented public policies aimed at enhancing innovation. In practice, the first explicit interventions to encourage innovation by the private sector emerged even earlier, toward the end of World War II. Although many of these policies were either abandoned or dramatically downsized under the structural reforms inspired by the Washington Consensus, the disappointing results in terms of productivity growth have led several countries in the region to reintroduce policies to stimulate innovation and encourage technology adoption.

This paper studies the determinants and sustainability of the widespread private capital inflows to middle-income countries after 1989. The key question is whether these flows are mostly ‘pulled’ by attractive domestic conditions or ‘pushed’ by unfavorable conditions in developed countries. An analytical model focusing on country risk is developed and used empirically. It is argued that the observed improvement in country creditworthiness is mostly due to the decline in international interest rates, and that therefore its importance as a proximate cause does not support the ‘pull’ interpretation. All things considered, in most countries the key answer that emerges is ‘push’.

The outlook for economic development for an important group of middle-income countries has again been buoyed by substantial private capital inflows in the 1990s. As in the 1970s, this development has been met with cautious optimism. It is generally accepted that these countries need resource transfers from the rest of the world to support capital formation and growth. It is also generally accepted that these private capital flows make the allocation of resources more efficient. But there is concern that a rapid reversal of market sentiment could impose considerable adjustment costs on these same economies. The authors try to quantify what many consider to be the main reasons debtor countries have access to capital markets again: (a) Domestic policy reform in the debtor countries. (b) Debt and debt service reduction, usually associated with Brady Plan restructuring. (c) Changes in the external market, such as changes in interest rates in industrial countries. They argue that a useful barometer for access to new loans is the market value of existing sovereign debt. It follows that a quantitative analysis of the factors that caused the market value of sovereign debts to rise rapidly after 1989 would also improve understanding of the forces behind the renewed access to international capital. Empirical historical evidence suggests that fiscal reform, privatization, and debt reduction are useful in explaining relative improvements in the standing of debtor countries in international credit markets. Debtor countries with strong reform programs, in other words, are better prepared to withstand deterioration in the external environment. But the reduction in dollar interest rates since 1989 appears to be the chief factor in the debtor countries' renewed access to international loans. The authors estimate the effect of increases in dollar interest rates and conclude that the typical debtor country remains vulnerable to increases in interest rates that are well within the range of recent experience.

Europe faces challenges reminiscent of Latin American financial crises, namely unsustainable sovereign spreads, banking system distress, sudden stops in capital flows and growth rate collapse. The failure of recent liquidity support to normalize the situation suggests the need to refocus the policy debate on fundamentals: structural reform for growth and, where needed, restructuring to resolve banking crises and the debt overhang. Latin America’s experience yields relevant policy lessons for Europe on all these fronts, tempered only by the slight exception that sharp real devaluation, which was key to spearheading recovery in Latin America, is unfeasible in the eurozone. Struggling eurozone countries are caught between a rock and a hard place, as the currency union imposes strict policy constraints while the reintroduction of national currencies under conditions of crisis would be catastrophic. Nevertheless, contemporary Europe stands a better chance of recovery because, in contrast with the Latin America experience, the European Union possesses greater avenues for international cooperation. With respect to financial support, a resourceful European Central Bank able to avoid chaotic adjustment by brute force is a decisive advantage of Europe relative to Latin America, which only had access to the weaker and less reliable IMF. Arguably, the limited nature of external support strongly contributed to the depth of Latin America’s great collapses. European cooperation can explore and exhaust alternatives to a euro exit to the benefit of all union members and, if dissolution becomes unavoidable, ensure amicable support to ease the transition. The path to success remains uncharted, however, and implementation of the necessary regional mechanisms will require innovation and political will. If the available means of cooperation are not used effectively, crisis countries in Europe may fare worse than those in Latin America. L’Europe rencontre actuellement des difficultés qui ne sont pas sans rappeler les crises financières latino-américaines : des spreads* insoutenables entre les dettes souveraines, un système bancaire fragilisé, de brusques renversements des flux de capitaux et un effondrement du taux de croissance. L'échec des récentes injections massives de liquidités pour tenter de normaliser la situation donne à penser qu’il est devenu indispensable de recentrer le débat politique sur les fondamentaux : réformes structurelles soutenant la croissance et, le cas échéant, restructurations en vue de résoudre les crises bancaires et le surendettement. Quant à la manière de régler tous ces problèmes, l’Europe peut tirer de l'expérience latino-américaine des enseignements fort pertinents, à cette nuance près cependant qu’une forte dévaluation en termes réels – fer de lance de la reprise en Amérique latine – est irréalisable dans la zone euro. Les pays en difficulté dans la zone euro sont pris entre le marteau et l'enclume : l'union monétaire impose de strictes contraintes politiques mais la réintroduction des monnaies nationales dans ces conditions de crise s’avèrerait catastrophique. Néanmoins, l'Europe contemporaine a de meilleures chances de se relever parce que, contrairement à l'expérience latino-américaine, l'Union européenne dispose de plus grandes possibilités de coopération internationale. En matière de soutien financier, la Banque centrale européenne dispose d’assez de ressources et d’ingéniosité pour éviter d’imposer un ajustement chaotique ; c’est un avantage décisif de l'Europe par rapport à l'Amérique latine, qui ne pouvait compter que sur le FMI, plus faible et moins fiable. Il est en effet incontestable que le caractère limité de l'aide extérieure a fortement contribué à la gravité des grands effondrements de l'Amérique latine. La coopération européenne a les moyens d’envisager et d’épuiser toutes les alternatives à une sortie de l'euro au bénéfice de tous les membres de l’Union et, si la dissolution devenait inévitable, d'apporter son soutien bienveillant à une transition en douceur. Personne ne sait quel chemin mènera à la réussite, cependant, et la mise en œuvre des mécanismes régionaux nécessaires exigera innovation et volonté politique. Si les moyens de coopération disponibles ne sont pas utilisés efficacement, les pays européens en crise risquent de s’en tirer plus mal que ceux d'Amérique latine. *Différences entre les rendements des obligations émises par certains pays moins bien notés par les agences et ceux des pays jouissant du triple A. Europa se enfrenta a desafíos que nos recuerdan a aquellos de las crisis financieras latinoamericanas, principalmente márgenes soberanos insostenibles, dificultades en el sistema bancario, interrupciones repentinas en los flujos de capital y colapso de la tasa de crecimiento. El reciente fracaso del apoyo a la liquidez para normalizar la situación sugiere la necesidad de reenfocar el debate político en lo fundamental: una reforma estructural para el crecimiento, y en los casos que sea necesario, una reestructuración para resolver las crisis bancarias y el sobreendeudamiento. La experiencia de Latinoamérica nos ofrece lecciones relevantes de políticas para Europa en todos estos frentes, considerando únicamente la ligera excepción de que una pronunciada devaluación real, punto clave para iniciar la recuperación en América Latina, es inviable en el caso de la Eurozona. Los países en dificultades de la Eurozona están atrapados entre la espada y la pared, ya que la unión monetaria impone estrictas restricciones políticas, mientras que la reintroducción de monedas nacionales bajo condiciones de crisis resultaría catastrófica. Sin embargo, la Europa contemporánea tiene una mejor posibilidad de recuperación, porque en contraste con el caso latinoamericano, la Unión Europea posee mayores opciones de cooperación internacional. Con respecto al apoyo financiero, la existencia de un Banco Central Europeo fuerte, capaz de evitar ajustes caóticos de forma impulsiva, es una ventaja decisiva para Europa en relación con Latinoamérica, donde sólo se tenía acceso al más débil y menos confiable FMI. Posiblemente, la naturaleza limitada del apoyo externo contribuyó marcadamente a la gran intensidad de los colapsos latinoamericanos. La cooperación europea puede explorar y agotar todas las alternativas a una salida del euro en beneficio de todos los miembros de la Unión, y, si la disolución se vuelve inevitable, garantizar un apoyo afable para facilitar la transición. No obstante, el camino al éxito continúa inexplorado, y la implementación de los mecanismos regionales necesarios requerirá innovación y voluntad política. Si los medios de cooperación existentes no se utilizan de manera efectiva, los países europeos en crisis podrían sufrir consecuencias más graves que aquellos en Latinoamérica.

Export Pioneers in Latin America analyzes a series of case studies of successful new export activities throughout the region to learn how pioneers jump-start a virtuous process leading to economic transformation. The cases of blueberries in Argentina, avocados in Mexico, and aircraft in Brazil illustrate how an initially successful export activity did not stop with the discovery of a single viable product, but rather continued to evolve. The book explores the conjecture that costly burdens to entrepreneurial self-discovery (due to the deterrent effects of imitation by competitors) have held back potential exporters in post-reform Latin America. It also considers the conjecture that new export activities are a complex enterprise that can only come to fruition when innovative contributions of many actors are somehow provided jointly.

This paper combines development and growth accounting exercises with economic theory to estimate the relative importance of total factor productivity and the accumulation of factors of production in the economic development performance of Latin America. The regions development performance is assessed by contrast with various alternative benchmarks, both advanced countries and peer countries in other regions. The paper finds that total factor productivity is the predominant factor: low productivity and slow productivity growth, as opposed to impediments to factor accumulation, are the key to understanding Latin Americas low income relative to developed economies and its stagnation relative to other developing countries. While policies easing factor accumulation would help somewhat in improving productivity, for the most part, closing the productivity gap requires productivity-specific policies.

In this paper we analyze the long-run relationship between output collapses—defined as GDP falling substantially below trend—and total factor productivity (TFP). We use a panel of 76 developed and developing countries during the period 1960–2004 to identify episodes of output collapse and estimate counterfactual post-collapse TFP trends. Collapses are concentrated in developing countries, especially Africa and Latin America, and were particularly widespread in the 1980s in Latin America. Overall, output collapses are systematically associated with long-lasting declines in TFP. We explore the conditions under which collapses are least or most damaging, as well as the type of shocks that make collapses more likely or severe. Furthermore, we provide a quantification of the associated welfare loss with output collapses.

In the first eight decades of the XX century, Brazil ranked among the countries with highest growth rates in the world. During the period 1930-80, in particular, it managed to reduce its per capita income gap vis-a-vis industrialized economies and seemed poised to escape underdevelopment early in this century. However, this dream never materialized; Brazil’s growth performance deteriorated sharply over the following quarter century, never fully recovering from the second oil shock and the foreign debt crisis. In this period Brazil experienced much lower and more volatile growth, with its long-term annual growth rate (ten-year moving average) fluctuating in the 2% to 3% range, well below the 6% to 10% range that prevailed in 1950-80. Brazil reacted by embarking on reforms, from trade liberalization to changes in fiscal and social policies. Policies improved, especially after price stabilization, in 1994, and, if anything, have been better than through most the high growth period, but apparently to no avail. Something happened in this later period that prevented Brazil from regaining the rapid growth that it had exhibited previously. What might it have been?

This paper combines development and growth accounting exercises with economic theory to estimate the relative importance of total factor productivity and the accumulation of factors of production in the economic development performance of Latin America. The region’s development performance is assessed by contrast with various alternative benchmarks, both advanced countries and peer countries in other regions. The paper finds that total factor productivity is the predominant factor: low productivity and slow productivity growth, as opposed to impediments to factor accumulation, are the key to understanding Latin America’s low income relative to developed economies and its stagnation relative to other developing countries. While policies easing factor accumulation would help somewhat in improving productivity, for the most part, closing the productivity gap requires productivity-specific policies.

This paper examines the countercyclical policy options available to Latin American countries in the face of the current global economic crisis, concluding that most of the major countries in the region appear to possess the fiscal space (as measured by credible fiscal sustainability and debt headroom) to run prudent countercyclical fiscal deficits. Those countries should undertake a constrained fiscal expansion focused on productive public spending and financed by “rainy day” funds—large stocks of foreign exchange reserves that they have accumulated during recent years—rather than by market borrowing. The recent surge in multilateral financial activity to alleviate market illiquidity, whether intended for reserve or budget support, strengthens the case for this policy prescription: with multilateral support, the appropriate policy response is more expansionary, and its financing is less reliant on market borrowing.

Economic growth in Latin America and the rise of material welfare has lagged behind that of more dynamic areas of the world economy. In a region prone to policy experiments, the policies of the Washington Consensus applied since the 1990s failed to bring sustained growth to most of Latin America. Andres Solimano and an impressive set of contributors analyze the last 40 years in order to determine the role of economic reforms, external conditions, factor accumulation, income inequality, political instability and productivity in explaining GDP increases. The book also looks at cycles of growth, identifying periods of rapid growth and contrasting them with periods of stagnation and collapse.

The negative effects on exports and FDI flows of an exchange rate misalignment are amplified when the misalignment is among countries that share a regional integration agreement. Such agreements strengthen the well-established relationship between real appreciation and currency crises. We conclude that coordination to achieve real-exchange-rate consistency within blocs is key to macro stability and, a fortiori, sustainable trade agreements.

At the time of writing there were widespread concerns about the health of the U.S. economy. There is conclusive evidence that the pace of growth has slowed, which has prompted the Federal Reserve to cut interest rates on two occasions (a total of 100 basis points thus far). As usual, when faced with this kind of turning point, analysts and policy makers alike wonder whether the United States will achieve a "soft landing" or whether the downturn is more serious and protracted in the worst scenario, the new weakness could signal the end of the new economy. Furthermore, recent inflation surprises have not been encouraging, as higher-than expected inflation numbers may curtail the Federal Reserve's desire and ability to act counter cyclically.

It has been common to attribute financial crises to short-term capital inflows, while foreign direct investment (FDI) is seen as a safer form of finance. The relationship between crises and the composition of capital flows is particularly relevant at present because the flow of capital to Latin America is becoming increasingly dominated by FDI. This paper asks whether the composition of capital inflows and of the stock of foreign liabilities is relevant for financial crises, be it their frequency, depth, or length. It explores the possible role of FDI as a benign form of external liability relative to other classes of liabilities, reviewing both analytical and empirical arguments.

After being excluded from world capital markets during the debt crisis, many developing countries have experienced large capital inflows in the past five years. The challenges these inflows pose for domestice policy have generated a substantial literature. The authors review and extend that literature. They characterize the new inflows, assess their causes and the likelihood of sustainability, analyze the policy issues they raise, and evaluate the possible policy responses. Their conclusions tie desirable policy responses to characteristics of both the flows themselves and to those of the recipient economy. Regarding the forces driving the current episode, they conclude that generally, the role of foreign interest rates as a "push" factor driving capital inflows and determining their magnitude has been well-established. On the other hand, country creditworthiness has helped determine both the timing and destination of the new capital flows. Even if creditworthiness is maintained, the early level of inflows is unlikely to be sustained. The pace of reduction in flows to countries that have been receiving them since the early 1990s depends on the path of foreign interest rates and the role of stock adjustment. But a loss of creditworthiness caused by a deterioration in domestic policy would stop inflows quickly and, depending on the circumstances, inflows may be replaced by substantial outflows and an outright balance of payments crisis.What are the implications for policy in recipient countries? Briefly, the receipt of capital inflows may strengthen the case for removing macroeconomic distortions, either because such inflows aggravate the cost of such distortions or because they ease the constraints that originally motivated their adoption. While direct intervention may not be feasible (because controls may be easily evaded), controls may sometimes be a second-best policy. To the extent that capital inflows are permitted to materialize, the desirability of foreign exhcange intervention depends on what is required for macroeconomic stability. Sterilized foreign exchange intervention to prevent overstimulation of demand with a fixed exchange rate may not be feasible or effective. A commensurate reduction in the money multiplier, achieved by increasing reserve requirements, may also have limited effects. The effectiveness of both measures depends on the structure of the domestic financial system. If domestic monetary expansion is not avoided, or if an expansionary financial stimulus is transmitted outside the banking system, the stabilization of total demand will require fiscal contraction.

The paper addresses the adequacy of post-reform growth in Latin America in the 1990s on the basis of international comparison and other relevant standards, analytically exploring and empirically testing a number of hypotheses to explain the perceived dissatisfaction with growth performance. It also estimates the long-run growth payoff of macroeconomic reforms, the additional gains that can be achieved by deepening this first generation of reforms, and the potential payoff from broadening the scope of reform into a second generation of reforms encompassing deeper structural and institutional areas.

The primary distinction in a North-South trade accord is likely to be that the Southern nation experiences more capital scarcity than its Northern trade partner. So the trade accord's impact on the Southern trading partner's ability to attract capital may have welfare implications for both nations. The authors extend the traditional analysis of customs unions to allow for international capital movements. Their results indicate that trade accords may affect the ability of Southern nations to attract capital and may divert capital between Southern nations. Moreover, the welfare implications of North-South trade accords may differ from those that predict the North American Free Trade Agreement's (NAFTA) minor third-country effects, holding factor endowments constant. The key implications of North-South trade accords such as NAFTA are generally perceived to involve their impact on investment flows. The authors try to understand the channels through which trade accords can affect North-South investment flows. A potential link between trade accords and investment flows may be how the accords affect the ability of the Southern partner government to make commitments about the treatment of foreign investment. They show that these accords can affect both the magnitude and pattern of inward foreign investment and production, implying the possibility that both trade and financial diversion can stem from a bilateral regional trade accord. Novel effects that emerge under sovereign risk must be addressed when assessing the welfare implications of trade accords. The greatest gains from integration are still achieved when integration takes place between the countries with the greatest potential gains from trade. But the authors make a distinction: these gains now include both current trade and inter-temporal trade through foreign investment.

This empirical study finds that while debt reduction and policy reforms in debtor countries have been important determinants of renewed access to international capital markets, changes in international interest rates have been the dominant factor. We calculate the effects of changes in international interest rates for a 'typical' debtor country. We conclude that increases in interest rates associated with business cycle upturn in industrial countries could depress the secondary market prices of existing debt to levels inconsistent with continued capital inflows.