From Global Collapse to Recovery

Economic Adjustment and Growth Prospects in Latin America and the Caribbean

THE WORLD BANK Office of the Chief Economist Latin America and the Caribbean 1818 H St. NW Washington, DC 20433 www.worldbank.org/lac

THE WORLD BANK

From Global Collapse to Recovery Economic Adjustment and Growth Prospects in Latin America and the Caribbean

Office of the Chief Economist Latin America and the Caribbean THE WORLD BANK

Foreword

This semiannual report—a product of the Office of the Chief Economist for the Latin America and the Caribbean Region of the World Bank—analyzes where the Latin America and the Caribbean (LAC) region stands following the global crisis, its growth prospects and main challenges. The first part of the report focuses on macroeconomic and financial aspects, emphasizing the outlook going forward. The second part examines some aspects of the adjustment in labor markets during this crisis in comparison to previous ones. The preparation of this report was led by Augusto de la Torre, Regional Chief Economist, in close collaboration with César Calderón, Tatiana Didier, Julian Messina, and Sergio Schmukler. Paula Pedro, María Virginia Poggio, and Carlos Felipe Prada provided outstanding research assistance. We would like to thank Tito Cordella, Francisco H. G. Ferreira, Samuel Freije-Rodríguez, Gladys López-Azevedo, William Maloney and Lars Christian Moller for their invaluable comments. We also extend our gratitude to M. Ayhan Kose (IMF) for providing us with the results of his research on the decomposition of business cycles into their global, regional, and idiosyncratic components.

From Global Collapse to Recovery

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Part I

Executive Summary

LAC Recovering in a Multi-Polar Global Economy

The global crisis is now in the rear view mirror and world growth is being restored. In sharp contrast with past episodes of global turmoil, this time the recovery is led by the periphery—specifically by the larger and more dynamic emerging markets (Brazil, China, India, South Korea, Malaysia, Philippines, and Thailand). For this group of emerging markets (EMs), the contraction in economic activity was much smaller than that of rich countries, the recovery started earlier, and the rebound has been much steeper. LAC is second among emerging regions, after Asia, in the strength of the recovery. LAC comes out of the crisis with a bruised “income statement”, no doubt, but its economic downturn in 2009 was less dramatic than that other of regions and it led to a milder than expected increase in unemployment when compared to past downturns. Moreover, LAC’s “balance sheet” was not impaired by the crisis. Due to greatly improved macro and financial policy frameworks in LAC, factors that used to magnify external shocks (i.e., weak currencies, weak fiscal processes, and weak banking systems) this time helped cushion the shock. Several LAC countries were able to conduct countercyclical policy, particularly in the monetary front, for the first time in decades. The effectiveness of countercyclical policies in LAC was complemented and enhanced by multilateral institutions’ sizeable, flexible, and timely provision of liquidity and budget-support financing. The current pattern of global recovery has favored LAC so far. Countercyclical policies have supported domestic demand in the larger LAC countries and external demand from fast-growing EMs, especially China, has boosted exports and terms of trade for LAC’s net commodity exporters—which are mainly located in South America and account for over 90 percent of the region’s population and GDP. Prospects for LAC in the short-term thus look good—regional economic activity is forecast to expand by a solid 4 percent in 2010. Beyond the cyclical rebound, however, a higher trend growth will not be as easy to sustain for LAC because future economic dynamics for the rest of the world are clouded by uncertainty and complexity. It is unclear if rich countries will be able to overcome the growth-impairing effects of high government indebtedness without a significant increase in inflation further down the line. And while growth in LAC (especially in South America) can continue on the strength of its ties to emerging Asia, there are doubts about the sustainability of China’s invest-

From Global Collapse to Recovery

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Office of Regional Chief Economist

ment-reliant/export-based growth model. A smooth shift towards more of a consumption-based growth model in China would be easier to achieve with the help of international macroeconomic policy coordination, which seems unlikely to materialize at this stage. While central banks in rich countries will have to keep interest rates low to support their sagging economies, EMs will have hike them earlier to control inflation expectations as signs of economic overheating surface. The resulting widening of the interest rate differential will further boost capital flows to LAC, intensifying policy tensions vis-à-vis the risks of an overshooting in the appreciation of LAC currencies (with potentially permanent adverse effects on export competitiveness) and excessive credit expansion (which may threaten financial fragility down the line). The policy debate in LAC going forward will thus tend to focus on macroprudential policies to dampen credit creation as well as on policies to curb undue currency appreciation (international reserve accumulation, controls on capital inflows, fiscal tightening). The region’s major longer-run challenge going forward will be to craft a bold productivity agenda. While the process of convergence towards rich-country standards of living has eluded LAC for more than a century, hopes that this trend may be changing emerged before the crisis, when several LAC countries other than Chile recorded visible productivity growth. With LAC coming out of this crisis relatively well positioned, such hopes are rekindling, especially considering that the improved macro-financial resiliency of the region gives greater assurance that future gains from growth will not be wiped out by financial crises. In addition, LAC has been making significant strides in the equity agenda and this could help mobilize consensus in favor of a long overdue growth-oriented reform agenda. But the jury is out on whether the region will be able to seize the opportunity to boost long-run growth, especially considering the large gaps that LAC would need to close in such key areas as saving, human capital accumulation, physical infrastructure, and the ability to adopt and adapt new technologies.

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From Global Collapse to Recovery

LAC’s natural resource wealth can broaden the scope for seizing the growth opportunity, but only if the associated windfall earnings are managed judiciously within a long-term horizon, so as to avoid falling victim to the so-called “natural resource curse.” A clear sign that the downside risks of commodity abundance are being avoided would materialize if commodity exporting countries mange to save (via cyclically adjusted primary fiscal surpluses) a substantial fraction of the commodity-related revenue windfalls.

After the fall, LAC stands tall As discussed in our previous semi-annual report of September 2009, “Update on the Global Crisis: The Worst is Over, LAC Poised to Recover,” the 2008–09 crisis reached its darkest phase in the fourth quarter of 2008 and the early months of 2009, when the global credit crunch originated in the US shut down all economic engines of world growth. During that time, the systemic and global propagation of the downturn dominated country-specific strengths and rates of economic growth took a nose dive across countries in a highly synchronized manner. A full meltdown of financial intermediation in the rich countries was averted and confidence began to stabilize, on the strength of a broad menu of unprecedented risk-absorption and stimulus policies, led by the U.S. Federal Reserve Bank. In the process, however, the balance sheets of public sectors in rich countries were weakened by a major increase in indebtedness, raising the risk of fiscal crises down the line (see below). While the downturn in growth was globally synchronized, economic performance and policy reactions varied across countries, with some coping better than others. Like most countries in the world, LAC came out of the crisis with a bruised “income statement” but, unlike rich countries and some of the emerging economies in Eastern and Southern Europe, LAC’s “balance sheet” was not impaired. This remarkable fact stands in sharp contrast with LAC’s own past experience, where domestic currency, banking and/or debt crises tended to wreak havoc at home following

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a major external shock. In other words, while LAC experienced a marked slowdown in growth it did not suffer systemic damage, and this has raised the relative attractiveness of many LAC countries as destinations for investment and placed them in a good position to resume growth. In particular, LAC’s recession in 2009 (a GDP contraction of 2.3 percent) was deeper than that of the East Asian Tigers (0.1 percent) but milder than that of highincome countries (3.4 percent) and Eastern Europe (5.7 percent) (Figure 1.A). Excluding Mexico, moreover, whose output contraction of about 6.5 percent was a regional outlier, LAC’s GDP hardly contracted in 2009. In addition, LAC’s “growth collapse” (the difference in GDP growth rates between 2009 and 2007) of 6.3 percentage points (pp), although large in absolute terms, was just under that of the industrial countries and East Asian Tigers (6.9 pp and 7.4 pp, respectively) and much smaller than that of Eastern Europe (12.9 pp) (Figure 1.B).

To be sure, the recession in LAC, while milder than expected, led to a partial reversal of the robust poverty reduction gains that the region achieved in the five years prior to the crisis. While 60 million Latin Americans are estimated to have left the poverty ranks during 2002–2008, some 9–10 million people joined the poor in 2009, and that number would have been greater had it not been for the fact that—again breaking with history—LAC governments were able to maintain, and in many cases actually step up, social assistance programs, including the very effective conditional cash transfers schemes that have become a LAC trademark in social policy. From a cross-country perspective, as analyzed in greater detail in Appendix I.A, growth collapses around the world tended to be larger in economies characterized by greater trade openness, higher trade dependence on rich country markets, higher share of manufacturing exports, and weaker banking systems. Moreover, improvements in LAC’s macro-financial

Figure 1  Real Growth and Growth Forecasts Across Regions A.  Growth Across Regions, 2009

B.  Growth Collapse

Real GDP Growth in 2009 Around the World Annual Real GDP Growth Rate

GDP Growth Collapses Around the World Differences Between Growth in 2007 and 2009

10%

0%

8%

–2%

6%

–4%

4% 2%

–6%

0%

–8%

–2%

–10%

–4%

–12%

–6% –8%

ECA

OECD

LAC

East Asian Tigers

SSA

MENA South Asia

China

–14%

ECA

East Asian Tigers

OECD

LAC

China

SSA

MENA South Asia

Note: Growth collapse is defined as the difference between the GDP growth rate in 2009 vis-à-vis growth in 2007. ECA refers to Eastern Europe and Central Asia countries. East Asian Tigers are Hong Kong,China; Indonesia; Korea,Republic of; Malaysia; Singapore; Taiwan,China; and Thailand. OECD refers to OECD-member countries. LAC refers to countries in Latin America and the Caribbean. SSA refers to SubSaharan Africa countries. MENA makes reference to Middle East and North African countries. Data comes from Consensus Forecast as of December 2009 for countries that have not published 2009 growth figures yet. Source: Bloomberg, IMF International Financial Statistics (IFS) and Consensus Forecasts.

PART I  LAC Recovering in a Multi-Polar Global Economy

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Office of Regional Chief Economist

Importantly, the flexible, sizeable, and timely provision of liquidity and budget support financing by multilateral financial institutions (including the IMF, World Bank, IDB, and CAF) complemented and boosted the ability

Figure 2  LAC: A Safer Integration Net Creditor

A Safer Integration in LAC 10% 5% 0%

Net Debt Position vis-a-vis Rest of the World

–5% –10% –15% –20% –25% –30% –35% –40%

Net Equity Position vis-a-vis Rest of the World

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Countercyclical capacity is a new and certainly notable feature in LAC’s macroeconomic policymaking, a region where in the past external shocks were instead amplified by weak macroeconomic fundamentals. This capacity, furthermore, is a fruit of steady institution building over the past 25 years involving a virtuous combination of: more robust monetary policy frameworks (including greater exchange rate flexibility and credible and professional central banks), more viable fiscal processes (although these tend to remain pro-cyclical in most of LAC, with the salient exception of Chile), sounder and better regulated banking systems, a significant reduction of currency mismatches in debtor balance sheets, and a safer integration into international financial markets. The latter reflects a process that begun in this millennium, whereby LAC became a net creditor to the rest of the world on the debt side (that is, the side where systemic vulnerabilities can easily arise) while the rest of the world has become an increasing net claimant on LAC on the equity side (that is, the side where systemic vulnerabilities are much less likely to emerge) (Figure 2).

of LAC’s more robust macro-financial and social policy frameworks to cushion the effects of the external shock.1 Indeed, the prompt response by multilaterals constituted a more prominent feature in the management of this crisis compared to previous ones. In this connection, a recent IDB study (Izquierdo and Talvi, 2010) that quantitatively assesses the impact of multilateral finance during the crisis finds that: (i) developing countries with access to multilateral resources outperformed those without it; and (ii) it was the combination of multilateral financial support and improved macro-financial fundamentals which enabled LAC to better withstand the crisis. The shock absorption capacity resulting from this combination also helps explain why labor markets in LAC behaved differently this time around, with unemployment rising less than in past crises (controlling for the size of the economic downturn) and the share of informal employment (surprisingly) not increasing. Part II of this report provides a detailed comparative analysis of the dynamics of labor markets in this and previous downturns.

Net Debtor

policy frameworks paid off. They enabled LAC to better cushion the external shock and undertake countercyclical policies, especially on the monetary front but also, to a lesser extent, on the fiscal side. While banking system weaknesses did not play a role in most LAC countries (with the possible exception of some Caribbean countries), the rest of the mentioned factors help explain why, for instance, the growth collapse was more pronounced in Argentina, Mexico, Costa Rica, Panama and Peru compared to, say, Brazil and Chile, and why the growth collapse was comparatively very small in, say, Bolivia.

Source: The net debt position (vis-à-vis ROW) is the sum of debt assets and reserves minus debt liabilities. In turn, the net equity position (vis-à-vis ROW) is the sum of net FDI assets and net portfolio equity assets. The sample ranges from 1990 to 2007. Source: Lane and Milesi-Ferretti (2007).

The World Bank’s commitments to disburse to the LAC region rose from an average of nearly US$ 5 billion per year during FY2003–FY2008 to around US$ 14 billion in FY2009. The average size of IBRD loan to countries in the region increased from US$ 116 million in FY2003–FY2008 to US$ 271 million in FY2009, as a large share of World Bank lending in 2009 took the form of fast-disbursing budget-support finance.

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From Global Collapse to Recovery

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The global recovery: contrasting paths for the center and the periphery A year has passed since the first signs of a recovery, or the so-called “green shoots,” started to sprout systematically across countries. For the world as a whole, the cyclical recovery has so far taken a sharper V-shape than was expected a year ago, not least because economic activity is rebounding from a very low base. There has been a strong and steady comeback in as-

set prices, a sharp compression of spreads over U.S. Treasury securities, and a robust pick-up in commodity prices. Moreover, world trade volume, after falling more than 20 percent between April 2008 and May 2009, has rebounded significantly, already reaching mid-2007 levels and thus attenuating fears of a tradeless recovery. Global liquidity remains abundant and a vigorous search for yield seems underway, spurred by low interest rates, and capital flows are returning to pre-crisis paths while increasingly being directed towards emerging markets (Figure 3).

Figure 3  Recovery in Financial Markets: A.  Stock Prices

B.  World Trade Volumes

Stock Prices Around the World Indexes: Jan-06=100 Stock Prices Around the World

World Trade Volumes Seasonally Adjusted, 2000=100 World Trade Index Volumes Seasonally Adjusted, Index 2000=100

LAC

145 150 140 145

ECA

UK

ECA

80

Japan

80

Japan

Jan-06 Jan-06 Mar-06 Mar-06 May-06 May-06 Jul-06 Jul-06 Sep-06 Sep-06 Nov-06 Nov-06 Jan-07 Jan-07 Mar-07 Mar-07 May-07 May-07 Jul-07 Jul-07 Sep-07 Sep-07 Nov-07 Nov-07 Jan-08 Jan-08 Mar-08 Mar-08 May-08 May-08 Jul-08 Jul-08 Sep-08 Sep-08 Nov-08 Nov-08 Jan-09 Jan-09 Mar-09 Mar-09 May-09 May-09 Jul-09 Jul-09 Sep-09 Sep-09 Nov-09 Nov-09 Jan-10 Jan-10 Mar-10 Mar-10

30 S&P

125 130 120 125 120

Net Private Capital Flows to Emerging Economies Net Private CapitalUS$ FlowsBillion to Emerging Economies US$ Billion Private Flows

1,000 800

Private Flows

800 600 600 400 400 200

FDI

2010f 2010f

2008 2008

2009f 2009f

2007 2007

2006 2006

2005 2005

Portfolio Equity Investment Portfolio Equity Investment

2004 2004

2003 2003

2002 2002

2001 2001

2000 2000

1999 1999

1998 1998

1997 1997

1996 1996

–200

Debt Investment

1995 1995

0 –200

FDI

Debt Investment

200 0

D.  Commodity Prices

Wheat, Copper Soybean, 01-Jan-05=100 Wheat, Copper and and Soybean, 01-Jan-05=100

C.  Capital Flows

1,200 1,000

Imports

135 140 130 135

30 S&P

1,200

Exports Imports

Commodity Prices Wheat, Copper and Soybean: Prices Index Jan-01-05=100 Commodity in Current US$ Wheat, CopperOil andWTI Soybean: Index Jan-01-05=100 Oil WTI in Current US$

350

150 130

Wheat

350 300

Wheat

130 110

Copper

300 250

Copper

250 200

150

Soybean Soybean

110 90

200 150

90 70

150 100

70 50

100 50 50

Oil (rhs) Oil (rhs)

50 30

Oil WTI, Oil WTI, Current Current US$US$

UK

Exports

155 160 150 155

Jan-06 Jan-06 Mar-06 Mar-06 May-06 May-06 Jul-06 Jul-06 Sep-06 Sep-06 Nov-06 Nov-06 Jan-07 Jan-07 Mar-07 Mar-07 May-07 May-07 Jul-07 Jul-07 Sep-07 Sep-07 Nov-07 Nov-07 Jan-08 Jan-08 Mar-08 Mar-08 May-08 May-08 Jul-08 Jul-08 Sep-08 Sep-08 Nov-08 Nov-08 Jan-09 Jan-09 Mar-09 Mar-09 May-09 May-09 Jul-09 Jul-09 Sep-09 Sep-09 Nov-09 Nov-09 Jan-10 Jan-10 Mar-10 Mar-10

180

LAC

Jan-06 Jan-06 Mar-06 Mar-06 May-06 May-06 Jul-06 Jul-06 Sep-06 Sep-06 Nov-06 Nov-06 Jan-07 Jan-07 Mar-07 Mar-07 May-07 May-07 Jul-07 Jul-07 Sep-07 Sep-07 Nov-07 Nov-07 Jan-08 Jan-08 Mar-08 Mar-08 May-08 May-08 Jul-08 Jul-08 Sep-08 Sep-08 Nov-08 Nov-08 Jan-09 Jan-09 Mar-09 Mar-09 May-09 May-09 Jul-09 Jul-09 Sep-09 Sep-09 Nov-09 Nov-09 Jan-10 Jan-10 Mar-10 Mar-10

EAP

180

130

165 170 160 165

EAP

230

130

170

Indexes: Jan-06=100

230

30

Note: EAP represents East Asia and the Pacific region. Note that the 2009 and 2010 figures on capital flows are forecasts from the Institute of International Finance. Source: Bloomberg, CPB (Netherlands Bureau for Economic Policy Analysis), and Institute of International Finance.

PART I  LAC Recovering in a Multi-Polar Global Economy

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Office of Regional Chief Economist

Thus, industrial production for the dynamic EMs fell by 13.4 percent from the peak, touched bottom in February 2009, and has been increasing sharply since then, reaching pre-crisis levels by the time of this writing (Figure 4). When emerging regions are compared, emerging Asia and LAC have dominated the recovery, posting posted cumulative gains of 18.7 and 9.1 percent in industrial production since their troughs, respectively. By contrast, average industrial production for the rich countries fell by 16.9 percent from its peak, reached bottom in May 2009, and has been rising sluggishly since then (a cumulative increase of only 3.5 percent in the May 2009-December 2009 period), thus remaining substantially below pre-crisis levels by the time of this writing. Moreover, capacity utilization in the rich countries is still below the minimum of previous downturns and unemployment rates remain at stubbornly high levels (slightly below 10 percent in the U.S., more than 8 percent in Germany, almost 20 percent in Spain, and still rising in France and Ireland). By contrast, available data suggest that capacity utilization and employment are at around pre-crisis levels for the dynamic EMs as well as for many countries in LAC.

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From Global Collapse to Recovery

Figure 4  World Industrial Production World Industrial Production Index Apr-08 = 100

105 100

Developed Countries

95 90 Emerging Economies

85

Jul-09

Oct-09

Apr-09

Jan-09

Jul-08

Oct-08

Apr-08

Jan-08

Jul-07

Oct-07

Apr-07

Jan-07

Jul-06

Oct-06

Apr-06

80 Jan-06

While global economic growth is being restored overall, there is great heterogeneity in the strength of the post-crisis recovery across regions and within regions. Growth engines are being reignited at different paces and intensities across nations. In particular and in sharp contrast with past episodes of global economic and financial turmoil, the recovery this time around has been led not by the center but by the periphery —specifically by the larger and more dynamic emerging markets (namely, Brazil, China, India, South Korea, Malaysia, Philippines, and Thailand, which jointly account for nearly 55 percent of emerging markets GDP). For this group of emerging markets (dynamic EMs), not only was the fall from peak to through in average industrial production smaller than that of the advanced economies (mainly the U.S., Europe and Japan) but the through was reached three months earlier and the rebound since then has been much steeper.

Note: The group of developed countries refers to OECD countries excluding Turkey, Mexico, Republic of Korea, and Central European countries. Source: CPB (Netherlands Bureau for Economic Policy Analysis).

Consistent with the heterogeneity of the recovery described above, GDP growth forecasts range widely across regions. The most recent forecasts (i.e., Consensus forecasts as well as IMF and World Bank projections) put growth in the rich countries at 2.1 percent for 2010 and 2.25 percent for 2011. The U.S. is envisaged to grow slightly above that average—flattening at 3.1 percent per annum during 2010–2011—and Western Europe somewhat below—at 1.2 percent in 2010 and 1.7 percent in 2011. By contrast, a much stronger rebound is forecast for the dynamic EMs. China is expected to post the highest growth rates, at 9.9 percent in 2010 and 9.1 percent in 2011. East Asia’s GDP is forecast to grow by 5.5 percent in 2010 (5.1 percent in 2011) and LAC’s economic activity is expected not to lag much behind, growing at a solid 4 percent per year during 2010–2011, with Brazil, Peru, Chile and Panama leading the pack (see below). The GDP growth forecast for countries in the Middle East and North Africa is 4.4 percent per year in 2010–11 whereas growth in Eastern Europe is the lowest among emerging market regions (3.5 percent) (Figure 5). The considerable variation in the recovery across countries is not surprising given that the idiosyncratic strengths of individual economies play a greater role as

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Figure 5  Regional Growth Forecasts for 2010 and 2011 Real GDP Growth Forecasts for 2010–2011 Annual Real GDP Growth Rate 12 2010

2011

10 8 6 4 2 0

Western Japan Eastern Europe Europe

US

LAC

MENA

East Asian Tigers

China

Note: Western Europe comprises Euro Zone countries, Denmark, Sweden, UK, Norway, and Switzerland. Source: Consensus Forecasts (December 2009 and March 2010), and Bloomberg.

the effect of the global systemic shock fades. A more systematic analysis of cross-country data suggests that this is indeed the case (Appendix I.B provides a more detailed analysis, including a comparison of the collapse-rebound patterns around the current and previous crises). In effect, countries that were able to conduct counter-cyclical policies are experiencing a faster recovery and so are countries that are experiencing a rebound in their net exports after the crisis. A purely arithmetic bounce-back effect also seems at play, as countries that recorded greater growth collapses also tend to register faster recoveries.

The recovery in LAC: things are looking good overall As noted, despite being one of the most financially globalized regions in the world, LAC is coming out of this crisis without systemic damage and is experiencing a relatively strong recovery in economic activity on average. This recovery was preceded by a strong V-shaped rebound in stock prices and a sharp compression of (sovereign and corporate) spreads. After reaching a trough in October 2008, stock prices in LAC recovered vigorously. The Brazilian stock price

index was back to its pre-crisis peak levels already by end-March 2010. Analogous behavior is observed in stock markets in Chile, Colombia, Mexico, and Peru. While LAC’s is forecast to grow by 4 percent in 2010 on a weighted average basis, there is significant heterogeneity in projected growth rates within the region. South America is envisaged to have a stronger recovery (4.7 percent over 2010–11) than Central America (4 percent) and the Caribbean (3.2 percent). Countries in LAC that are experiencing stronger rebounds tend to be characterized by: (i) vigorous expansion in domestic demand; (ii) extensive use of countercyclical policies; (iii) economic complementarity to Asia (especially China); and (iv) commodity abundance. The leader is Brazil, where industrial production has increased by almost 20 percent from the trough and its 2010 GDP growth forecast is at 5.5 percent. Peru, Chile, Panama and Mexico are also expected to record relatively faster GDP growth within the region—between 4 and 5 percent in 2010. Growth rates in the 3–4 percent range for 2010 are expected for Argentina, Bolivia, Colombia, Costa Rica, Dominican Republic, Paraguay, and Uruguay. Lagging behind but rebounding nevertheless are most countries in Central America and the Caribbean. Lastly, Jamaica and Venezuela are expected to grow very little or even contract in 2010 (Figure 6). A few countries in LAC may begin to face the risk of economic overheating, with inflationary pressures expected to increase over the next months. Brazil is the most visible case in point—economic activity is beginning to expand at a pace above the pre-crisis trend growth and inflation forecasts are already above the center of the targeted inflation. Moreover, the fiscal and quasi-fiscal stimulus measures taken in Brazil, which are estimated to have totaled around 4 percent of GDP, will likely not be undone in the near future due mostly to the electoral cycle. Hence, markets expect the initiation of a monetary policy tightening in the near future. For many countries in the region, however, output is expected to remain below potential (Mexico and Colombia) and/or inflationary pressures are not yet mounting to significant levels (Peru and

PART I  LAC Recovering in a Multi-Polar Global Economy

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Office of Regional Chief Economist

Figure 6  Growth Forecasts for 2010 and 2011 among LAC Countries B.  2011 Growth Forecasts

Real GDP Growth Forecasts for 2010 LAC countries

Real GDP Growth Forecasts for 2011 LAC countries

6.0%

5.0%

5.0%

4.0%

4.0%

3.0%

3.0%

2.0%

2.0%

1.0%

1.0%

0.0%

0.0%

–1.0%

–1.0% –2.0%

–3.0%

–3.0%

Venezuela Ant. & Barb. Bahamas St. Kts. & Nv. Barbados Jamaica St. Vc. & Grs. Dominica St. Lucia Nicaragua Belize Guatemala Haiti Tri. & Tob. Honduras Ecuador Guyana Colombia Costa Rica Dom. Rep. Paraguay Suriname Bolivia Argentina Uruguay LAC Mexico Panama Chile Peru Brazil

–2.0%

Venezuela St. Vc. & Grs. Haiti Jamaica Belize Nicaragua Argentina Ecuador Guatemala St. Lucia Honduras Dominica Guyana Mexico Colombia Uruguay LAC Costa Rica Paraguay Bolivia Dom. Rep. Brazil Peru Chile Panama

6.0%

A.  2010 Growth Forecasts

Source: Latin American Consensus Forecasts as of March 2010, IMF’s World Economic Outlook, IMF’s Regional Economic Outlook.

Chile). After engineering a massive cut in policy rates (Figure 7), Latin central banks are thus expected to start a gradual normalization of interest rates, but the timing and extent of interest rates increases will likely vary significantly across countries depending on the output gap and inflationary expectations (Figure 8).

For the small, open economies in Central America and the Caribbean, where the scope for independent monetary policy is very narrow or non-existent, domestic price increases will tend to reflect developments in import prices (including foods and fuels) as well as supply conditions in the agricultural sector. Be it as it

Figure 7  Output Gap and Inflation A.  2010

B.  2011

2010 Output and Inflation Gaps

2011 Output and Inflation Gaps

0.001

0.0006 0.0002

0

COL

–0.0005

CHL

DOM

SLV

–0.001 –0.0015 –4

BOL PRY PAN ECU GUA MEX

–2

0

2

HND

–0.0004 –0.0006

PER PAN

MEX COL

ARG

SLV GUA

–0.001

NIC

Inflation Pressure in percentage points

–0.0002

BOL

CHL

–0.0008

CRI

4

PRY

0

ARG

BRA

PER

Output Gap

Output Gap

0.0005

URY

BRA

0.0004

URY

ECU

–0.0012 6

–0.0014 –2

DOM

CRI

NIC

HND

0

2

4

6

Inflation Pressure in percentage points

Note: Inflation pressures are calculated as the difference between the 2010 inflation rate forecast and an estimated target of 4% (assumed to be the target for most countries in the region). The output gap calculated as the difference between the (log of) actual and potential GDP, with the latter being calculated using the Hodrick-Prescott filter. Source: LCRCE Staff calculations based on Consensus Forecasts as of March 2010.

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From Global Collapse to Recovery

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Figure 8  Monetary Policy Rates in LAC countries

15.0%

Monetary Policy Rates Inflation-Targeting Latin American Countries and the US Brazil

13.0% 11.0% 9.0% 7.0%

very short-run, however, is plagued by great complexity and uncertainty. Some of the regional differences and relevant factors affecting growth prospects outside LAC are briefly and selectively discussed in the rest of this section.

Colombia Mexico Peru

Chile

5.0% 3.0%

US

1.0% Jan-10

Mar-10

Nov-09

Jul-09

Sep-09

Mar-09

May-09

Oct-08

Dec-08

Aug-08

Apr-08

Jun-08

Feb-08

Oct-07

Dec-07

Jun-07

Aug-07

–1.0%

Source: Bloomberg.

may, as interest rates increase in most of LAC while remaining low in rich countries, capital inflows are likely to surge, creating complex challenges for LAC central bankers, as discussed in more detail below.

Global growth prospects: obscured by clouds Whereas the prospects for growth in LAC countries in the near future are promising, the region is not isolated from the world economy and a significant fraction of the downside risks to growth lies in the external environment. To be sure, due to the mentioned substantial improvements in macro-financial policy frameworks LAC is much less vulnerable to shocks than it used to be. Hence, domestic macro-financial crisis are arguably less likely than in the past to erase LAC’s gains from growth going forward. But the sad fact remains that LAC has not managed to sustainably grow above the world average during the last hundred years! In general, LAC’s growth has tended to track closely global growth. Full decoupling between LAC’s growth and world growth is thus a chimera, implying that the growth prospects for LAC can only be assessed in the context of the growth prospects for the world. Growth in the rest of the world beyond the

One important point to keep in mind in this regard is that, as the region diversifies its linkages to the rest of the world, the sources and nature of external shocks will also diversify. In particular, shocks coming from other emerging countries may become increasingly more relevant for LAC in the future. The volatility of such shocks may be higher than those coming from international financial markets and rich country demand for LAC exports. In the past, LAC’s trade was on average mostly linked to the U.S. and, to a lesser extent, Europe. The region now relies much more on external demand from other emerging markets, particularly China and the South East Asian countries (Figure 9). Kose, Otrok and Prasad (2008) find that business cycles among LAC-7 countries are increasingly accounted for by “regional” factors (that is, factors affecting individual regions rather than the whole world) and, although there is no one-to-one mapping, it is likely that those regional factors are mainly driven by regional shocks. As a result, the share of output variation for LAC-7 countries accounted for by regional

Figure 9  Variation in Export Market Shares in LAC Variation in Export Market Shares for LAC Countries 2008 vs. 1990, in percentage points 20%

Euro Zone

US

China

15% 10% 5% 0% –5% –10% –15%

ARG BRA CHL COL ECU MEX PER

PRY URY VEN

Source: IMF’s Direction of Trade Statistics (DOTS).

PART I  LAC Recovering in a Multi-Polar Global Economy

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Office of Regional Chief Economist

factors increased from 1.3 percent to 7.8 percent on average between 1960–1984 and 1985–2008, reaching almost 16 percent in Peru and 10 percent in Brazil. Global (rather than “regional”) factors (i.e. related to fluctuations affecting the entire world) are nonetheless still important for LAC, explaining more than 17 percent of output variations in Brazil and around 9 percent for non-LAC7 countries (e.g., mainly Central American and the Caribbean countries) (Figure 10).2 Consider now the growth prospects for the rich countries. The recovery in the United States has so far been driven mostly by a restocking of inventories, massive stimulus policies, and a revival of net exports. There is uncertainty about the sources of future growth as the process of inventory restocking ends and the effects of the stimulus fizzle away—towards the second half of this year in the absence of additional stimu-

lus injections. So, prospects will largely depend on domestic private demand, which is still relatively weak and shows no clear signs of a solid recovery yet. Moreover, the management of the crisis implied that balance-sheet problems shifted from the private to the public sector, and this is likely to pose downside risks to a sustainable growth path in the medium term. The extraordinarily high level of government indebtedness significantly limits the scope for fiscal expansionary policies and this shifts the countercyclical burden to monetary policy. While the U.S. Fed is already unwinding some credit support facilities that help stabilized the financial system, interest rates in the U.S. are likely to remain at near-zero for a while in order to continue providing an expansionary impulse to the economy. But this, in the absence of vigorous and well-designed regulatory reform, may foster a buildup of financial excesses similar to those that led

Figure 10  The Increased Importance of Regional Factors and Decreased Global Ones A.  Global Factors

B.  Regional Factors

Percentage of Output Fluctuations Explained by Global Factors 50.0%

Percentage of Output Fluctuations Explained by Regional Factors 22.0%

1960–1984

45.0%

1985–2008

40.0%

1960–1984 1985–2008

17.0%

35.0% 30.0%

12.0%

25.0% 20.0%

7.0%

15.0% 10.0%

2.0%

5.0% 0.0%

–3.0% Colombia Venezuela, Brazil RB

Mexico

Peru

Chile Argentina

Venezuela, Mexico RB

Brazil

Chile

Peru

Colombia Argentina

Note: Global factors encompass all fluctuations that are common among industrial countries, emerging markets and other developing countries. Regional factors capture fluctuations that are common only within a particular group of countries (say, emerging markets). Source: Kose, Otrok, and Prasad (2008).

Kose, Otrok and Prasad (2008) use dynamic factor models to decompose the fluctuations in output, consumption and investment for a sample of 106 countries over the period 1960–2008 into global factors, regional factors, country factors, and idiosyncratic factors. The global factor includes all fluctuations that are common to industrial countries, emerging markets and other developing countries, and across all variables. Regional factors, on the other hand, are those that capture fluctuations that are common only to a particular group of countries, and across all variables. For instance, the regional factors for LAC-7 countries involve fluctuations affecting only theirs and other emerging markets’ output, consumption and investment.

2 

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From Global Collapse to Recovery

The World Bank

to the crisis. Moreover, there are strong doubts that the U.S. will be able to grow at the very high rates, or undertake the extent of fiscal adjustment, required to restore public sector debt to robust viability. This, in turn, raises the inflation specter—i.e., the specter that debt might have to be inflated away down the road. In Western Europe things look even worse and overall growth prospects are grim, although there is a wide variation in macro-financial circumstances among its countries. The forces of Western European growth recovery have been the same temporary ones at work in the U.S.—inventory restocking and stimulus packages, along with net exports. Domestic demand is also at depressed levels and investment is not expected to pick up significantly in the near future. But the challenges for growth in Western Europe are more daunting. Unemployment is extremely high and unyielding, not least because of the well-known rigidities in European labor markets which are politically difficult to alter. Perhaps more importantly, the European Union (EJU) does not have the flexibility to tailor monetary policy to the different needs of different EU countries. In the absence of differentiated exchange rate adjustment mechanisms and given the severe restrictions on the ability to transfer fiscal resources among Euro members, recessionary forces are likely to be stronger and more persistent. This is particularly troublesome for EU countries with high debt levels and/or weak fiscal stances such as Greece, Ireland, Italy, Portugal, and Spain. The problems with Greece’s debt have already led to increased fears of a double-dip recovery path in the EU, as the contractionary effects of fiscal austerity measures may spread.3 Given the sluggish recovery and the challenges faced on the fiscal side, an exit from the monetary stimulus is unlikely to occur soon, and interest rates in the EU will also remain at very low levels for a while.

Japan has experienced a slow export-based recovery so far. But it has still not seen a recovery in domestic (consumption and investment) demand and unemployment remains high. Moreover, the export-led rebound might slow down as inventory restocking ends. The country remains caught in a long-lasting liquidity trap, with deflationary pressures ensuring that interest rates will stay at near zero levels. The lack of room on the monetary policy front is putting an excess burden on fiscal policies. However, the country does not have much space on this front due to its large (gross) debt position of almost 200 percent of GDP. Turning now to emerging markets, China is playing an important role in the world’s recovery. During the crisis, its main engine of growth, exports, collapsed. To sustain economic activity, the government launched a massive and unprecedented stimulus focused on infrastructure investments at the local government level, which were spurred by a gigantic increase in domestic credit. The resulting investment boom in China (investment is estimated to have risen to nearly 60 percent of GDP) led to a sharp rise in imports, particularly of industrial metals and minerals, which contributed to the rebound in commodity prices and helped with the recovery in other emerging markets, including of course the net commodity exporting countries of South America. However, household consumption in China seems to be growing at the same pace as real GDP (even if real wages seem to be rising a bit faster), suggesting that the high domestic saving rate has remained essentially unchanged. While China is expected to continue to grow strongly in the short-run, as its stimulus dwindles (a few measures have already been taken towards a normalization of conditions) uncertainties rise about the durability and sustainability of China’s investment-based growth pull on the rest of the world.4

A resolution to Greece’s debt sustainability problems seems to be underway with both the IMF and Euro zone members involved in a rescue package, but this will have to be accompanied with painful fiscal austerity measures. 4  China is capable of designing the appropriate mix of policies to stimulate domestic demand, and consumption in particular, if external demand indeed remains weak. This would entail a shift towards a domestically-oriented growth model. Another way to stimulate domestic (private) consumption is the real appreciation of the Chinese Yuan. Real appreciation can be achieved through either domestic price inflation or a change in the current exchange rate policy. This is more likely to happen through a slow and gradual change in the nominal exchange rate in the event of high inflation. In the event of mounting inflationary pressures, Chinese authorities may allow the exchange rate to gradually adjust, thus giving a boost to domestic consumption. 3 

PART I  LAC Recovering in a Multi-Polar Global Economy

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Office of Regional Chief Economist

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From Global Collapse to Recovery

Figure 11  Gross nominal liabilities for developed countries and LAC-7 Gross Nominal Liabilities % of GDP 200

200

2007

2010

167

160 120 98

80

63

89

89

100 74

71 47

40 0

33 33

US

Euro

Japan

UK

OECD

LAC-7

Source: EIU and Consensus Forecasts (various issues).

Figure 12  Required Fiscal Adjustments Required Fiscal Adjustment Between 2010 and 2020 To Reach Debt Levels of 60% in % of GDP 20

Developed Countries

15 10 Other Emerging Economies

5

Latin America

–5

Germany Italy France Portugal Spain UK US Japan Ireland Greece

0

Hungary Bulgaria Ukraine Turkey Philippines Indonesia Russia Romania South Africa

In sum, the prospects for global growth are clouded by great uncertainty and complexity regarding at least two main questions. The first question is whether rich countries will be able to overcome the growth-impairing effects of their damaged balance sheets (Figure 11). The difficulty involved in meeting this challenge is clear when one considers the large size of primary fiscal surpluses that the U.S., Europe and Japan would have to generate in order to bring down their debts to sustainable levels without inflation (Figure 12). The second question is whether Asian EMs will be able to sustain in the medium-term their current growth pattern. This is equally uncertain considering that their current growth model remains frankly reliant on exports. While the domestic market has played an important role in the recovery for some of the dynamic EMs (including Brazil), world consumption demand needs to be recomposed to put world export growth on a high and sustainable path over the mediumterm. Ideally, more consumption demand will have to come from the surplus EMs, Germany and Japan (and less from the U.S.) and this is difficult to envisage in the absence of stronger currencies in Asia, particularly China. But it is utterly unclear whether and how this might happen in the absence of effective international macroeconomic policy coordination involving not just the rich countries but also the dynamic EMs. That type of coordination unfortunately appears unfeasible in the near future. In the meantime, how-

ever, capital flows to EMs are likely to pick up further as the interest rate differentials rise—that, is, as EMs increase interest rates to control inflation expectations in the midst of a possible economic overheating while rich countries keep interest rates low to stimulate their sagging economies.

Colombia Brazil Chile Mexico Peru Argentina

The significant growth recovery in other Asian countries has been driven by their position in the global production chain, including in particular the integrated distribution of manufacturing production stages within Asia. Together with China and India, East Asian countries, have been the main drivers of global growth since January 2009 and will likely continue to be so in the near future. At the same time, however, with actual GDP growth rapidly approaching potential growth, inflationary pressures are surfacing, and this is inducing Asian EMs to normalize monetary conditions and even initiate the cycle of monetary policy tightening that would cool down growth. Malaysia already raised the policy interest rate and others are expected to follow soon.

Source: IMF Fiscal Affairs Deparment, 2010. “Strategies for Fiscal Consolidation in the Post-Crisis World.” Washington, DC: IMF, February.

The World Bank

Challenges ahead for LAC So far for LAC, the pattern of global recovery discussed above has brought benefits. Countercyclical policies have supported domestic demand in the larger LAC countries and external demand from fast-growing EMs, especially China, has boosted exports and terms of trade for LAC’s net commodity exporters—which are mainly located in South America and account for over 90 percent of the region’s population and GDP (Figure 13). Until now, moreover, the rebound in commodity prices and relatively fast pace of recovery in LAC has not awaken major inflationary pressures. This has hitherto allowed LAC central bankers to keep interest rates low and this has, in turn, helped dampen the pressures for LAC currencies to strengthen relative to other currencies. Things will not be as easy for LAC going forward, however, given the prospects and policy complications outside LAC as discussed in the previous section. This section briefly discusses some of the challenges ahead for LAC. Living with capital inflows and exchange rate appreciations As noted, interest rate differentials (already at nontrivial levels given the near zero rates in developed countries) will widen further, likely leading to greater capital flows to LAC. And this will happen in a context where foreign capital, especially from the equity side, is already flowing to LAC in considerable amounts, not least because of many LAC countries withstood the global crisis well and came out of it as relatively more attractive destinations for investment. The pressures for LAC currencies to appreciate will be further enhanced in the case of commodity exporters—where a commodity export boom can easily materialize. Consequently, countries in the LAC region will continue to face significant challenges in the monetary/ exchange rate front. Having moved to more robust monetary policy frameworks that rely on greater exchange rate flexibility, and given a generally limited scope for fiscal policy adjustment, the feasible fiscalmonetary policy mix will likely shift the burden to-

Figure 13  Terms of Trade Cumulative Change in Terms of Trade Bolivia Ecuador Chile Paraguay Trin. & Tob. Colombia Peru Argentina Mexico Uruguay Brazil Panama Guatemala Costa Rica Nicaragua Dominica Dom. Rep. Honduras –40% –20%

2008q4–2009q4 2001q4–2008q2

0%

20% 40%

60%

80% 100% 120%140%

Note: The cumulative variation in the terms of trade index is calculated using quarterly data. The blue bars represent the cumulative percentage change during the recent commodity price boom up to the peak in 2008q2. The red bars capture the cumulative percentage change in terms of trade from its trough in 2008q4 to the most recently available quarter (2009q4). Source: WDI, DECPG, and Haver Analytics.

wards monetary policy. LAC policy makers will thus likely face increasingly difficult policy tensions vis-àvis the risks of overshooting in currency appreciations (which could inflict adverse and permanent effects on export competitiveness) and capital inflows-induced excessive credit expansion (which could weaken the financial system down the line). There is of course no easy way out of these tensions. The option to step up exchange rate intervention—aimed at dampening appreciation pressures—will naturally be considered despite its costs—for it calls for a significant degree of sterilization, via the issuance of relatively expensive local-currency debt securities, of the monetary impact of such intervention. The ongoing strengthening of LAC currencies and/or the accumulation of international reserves in several LAC countries (e.g., Brazil, Chile, Colombia, Mexico, and Peru) already reflects the interventions in the exchange rate market motivated by the need to find a reasonable balance in the face of the tensions (Figure 14). Not surprisingly, therefore, alternative options to “lean against the wind” in exchange rate markets might

PART I  LAC Recovering in a Multi-Polar Global Economy

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Office of Regional Chief Economist

Figure 14  Exchange Market Pressures A.  Brazil

B.  Chile

8 6 8

3

4 6

2 3 1 2

2 4

0 1

Jan-03Jan-03 May-03May-03 Sep-03Sep-03 Jan-04Jan-04 May-04May-04 Sep-04Sep-04 Jan-05Jan-05 May-05May-05 Sep-05Sep-05 Jan-06Jan-06 May-06May-06 Sep-06Sep-06 Jan-07Jan-07 May-07May-07 Sep-07Sep-07 Jan-08Jan-08 May-08May-08 Sep-08Sep-08 Jan-09Jan-09 May-09May-09 Sep-09Sep-09 Jan-10Jan-10

–4 –2

Reserve Accumulation Appreciation Pressures Exchange Market Pressure Reserve Accumulation Appreciation Pressures Exchange Market Pressure

–4

8

C.  Colombia

6 8 4 6 2 4 0 2 –2 0

Jan-03Jan-03 May-03May-03 Sep-03Sep-03 Jan-04Jan-04 May-04May-04 Sep-04Sep-04 Jan-05Jan-05 May-05May-05 Sep-05Sep-05 Jan-06Jan-06 May-06May-06 Sep-06Sep-06 Jan-07Jan-07 May-07May-07 Sep-07Sep-07 Jan-08Jan-08 May-08May-08 Sep-08Sep-08 Jan-09Jan-09 May-09May-09 Sep-09Sep-09 Jan-10Jan-10

–4 –2

Reserve Accumulation Appreciation Pressures Exchange Market Pressure Reserve Accumulation Appreciation Pressures Exchange Market Pressure

–4

–1 0 –2 –1 –3 –2

Reserve Accumulation Appreciation Pressures Exchange Market Pressure Reserve Accumulation Appreciation Pressures Exchange Market Pressure

Jan-03Jan-03 May-03May-03 Sep-03Sep-03 Jan-04Jan-04 May-04May-04 Sep-04Sep-04 Jan-05Jan-05 May-05May-05 Sep-05Sep-05 Jan-06Jan-06 May-06May-06 Sep-06Sep-06 Jan-07Jan-07 May-07May-07 Sep-07Sep-07 Jan-08Jan-08 May-08May-08 Sep-08Sep-08 Jan-09Jan-09 May-09May-09 Sep-09Sep-09 Jan-10Jan-10

–2 0

–3

5 4 5 3 4 2 3 1 2 0 1 –1 0 –2 –1 –3 –2

D.  Peru

Reserve Accumulation Appreciation Pressures Exchange Market Pressure Reserve Accumulation Appreciation Pressures Exchange Market Pressure

Jan-03Jan-03 May-03May-03 Sep-03Sep-03 Jan-04Jan-04 May-04May-04 Sep-04Sep-04 Jan-05Jan-05 May-05May-05 Sep-05Sep-05 Jan-06Jan-06 May-06May-06 Sep-06Sep-06 Jan-07Jan-07 May-07May-07 Sep-07Sep-07 Jan-08Jan-08 May-08May-08 Sep-08Sep-08 Jan-09Jan-09 May-09May-09 Sep-09Sep-09 Jan-10Jan-10

0 2

–3

Note: The Exchange Market Pressure Index is the weighted average of year-on-year percentage changes in: (a) the nominal exchange rate of the local currency vis-à-vis the US dollar (such that an increase represents an appreciation of the LAC currency), and (b) the level of international reserves. The weights are given by the inverse of the annual standard deviation of the changes in the nominal exchange rate and the standard deviation of the changes in reserves. An increase in the Exchange Market Pressure index signals appreciation pressures and/or accumulation of reserves. Source: LCRCE Staff calculations based on IMF’s IFS.

become an important item in the monetary policy debate in LAC going forward. To the extent that currency appreciation in LAC would be lower if China’s currency were allowed to strengthen, LAC countries might also interpret their intervention in exchange rate markets as a way to offset a global distortion. The actual mix of policies will, however, depend on whether flows and associated appreciation pressures are perceived to be permanent or temporary. Controls on capital inflows, as pointed out in a recent IMF Staff Position Note (Ostry et al, 2010), is likely also to be part of the menu of op-

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From Global Collapse to Recovery

tions, although these controls might bring distortions to financial systems that would be hard to reverse in the future. Furthermore, such controls tend to be easy to circumvent and thus become less and less ineffective over time. Alternatively, LAC authorities might focus on averting the excessive credit expansion that could result from the surge in capital inflows. In this case, macroprudential policy tools could be considered, including, for instance, unremunerated reserve requirements on financial intermediaries and/or counter-cyclical prudential (capital or provisioning) norms. Lastly, although

The World Bank

Some of the key conditions for LAC to raise its growth rate sustainably above the world’s average are, therefore, in place. But the jury is still out on whether the region will be able to seize the opportunity, as LAC faces a very tall order in this regard. Seizing the opportunity will require well-designed, but not necessarily

80.0% 70.0%

Interwar Period

60.0%

US Recovers

Gold Standard Period

50.0%

Alliance for Progress

Lost Decade

Imports Substitution

Washington Dissensus

Washington Consensus

40.0% LAC/US

30.0% 20.0% 10.0%

Asian Tigers/US

2002

2008

1996

1990

1984

1978

1972

1966

1960

1954

1948

1942

1936

1924

1930

1918

0.0% 1912

With the possible exception of Chile, LAC has failed to engineer sustained high growth. The process of convergence towards rich-country standards of living has in fact eluded LAC for more than a century, in sharp contrast with the East Asian tigers where convergence has been taking place at a rapid rate since the 1970s (Figure 15). Some hope that this trend may be changing emerged before the crisis, during the 2002–2008 period, where several LAC countries other than Chile (chiefly Peru and Panama, but also Brazil and Colombia) recorded significantly higher growth rates than in rich countries on the strength not just of favorable external conditions (low interest rates, abundant liquidity, and high commodity prices) but also of productivity growth. With LAC coming out of this crisis relatively well positioned, those hopes appear to be rekindling. Moreover, as noted, the improved macro-financial resiliency of the region gives greater assurance that whatever gains from growth that LAC could achieve in the future will be less likely to be wiped out by financial crises, as tended to be the case in the past. In addition, LAC has been making significant strides in the equity agenda—through noticeable improvement in poverty-reducing social policies—and this could help mobilize consensus in favor of a long overdue reform agenda aimed at raising productivity growth.

Relative GDP Per Capita of Selected Regions relative to the US

1906

Assembling a productivity agenda while averting the downside risks of commodity wealth

Figure 15  Trends in GDP per capita of Latin America and East Asian Tigers vis-àvis the United States

1900

harder to implement, fiscal tightening will also have to be considered, as it could allow interest rates to be lower, and the real exchange rate to appreciate less, than otherwise. In the end, with no simple solution in sight, countries in LAC are likely to have to learn to live with more appreciated real exchange rates, for which the only lasting solution is productivity growth.

Note. The group of East Asian tigers includes Hong Kong (China), Indonesia, Malaysia, Republic of Korea, Singapore, Thailand, and Taiwan (China). Source: LCRCE Staff calculations based on Maddison (2007, 2009), WDI and DECPG.

numerous or unduly complex, policies to ignite growth that are adequately tailored to the circumstances of individual countries. Once ignited, growth would have to be sustained through perseverant and major reform efforts aimed at eliminating well-know obstacles that undercut efficient resource allocation—such that competitive market forces are honed and relative prices better reflect relative scarcities. Also, the large gaps that LAC has in education, physical infrastructure, and the ability to adopt and adapt new technologies relative to, say, the Asian Tigers would have to be systematically closed. The associated need for high investment levels would have to be supported via higher national savings (and the willingness to keep savings in the country) as well as prudent access to foreign savings, particularly in the form of FDI. That would in turn require a leap in the quality of the investment climate, including through a better contractual and informational environment, much reduced corruption levels, sensible regulation, a major reduction in crime and violence, a major thinning of red tape, etc. The scope for seizing the opportunity to move to a higher growth path can be greatly enhanced in commodity

PART I  LAC Recovering in a Multi-Polar Global Economy

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Office of Regional Chief Economist

rich countries. But this can become a reality only if the associated windfall earnings are managed judiciously within a long-term horizon, so as to avoid falling victim to the so-called “natural resource curse.” This would require that policies and institutions are in place to dampen the possible welfare-reducing “Dutch Disease effects” (via an overvalued currency that unduly hinders non-commodity export diversification) and “rent-seeking effects” (i.e., the weakening of institu-

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From Global Collapse to Recovery

tions and work effort that could result from the ability of special interests to capture the natural resource rents to boost wasteful current spending). A clear sign that these bad side effects are being avoided would be given by a demonstrated ability of governments to save a substantial fraction of the commodity-related revenue windfall—that is, by the materialization of significant and continuous cyclically-adjusted primary fiscal surpluses going forward.

Part II

Executive Summary

Labor Markets in LAC during the 2009 Downturn:

In a refreshing break from the past, economic activity in the Latin American and Caribbean (LAC) region was not hit as hard by the global financial crisis as in previous recessions, or as compared to other regions. In addition, controlling for the size of the economic downturn, the region experienced significantly milder labor market adjustments than in previous crises. Unemployment did increase (about 3.5 million joined the ranks of the unemployed) but at a slower pace than in the recessions of the late 1990s. Perhaps even more surprisingly, the share of informal employment —a commonly used indicator of deterioration of the quality of employment—did not rise. These mild quantity adjustments in the labor market are especially puzzling in light of evidence that real wages in LAC did not decline during the 2009 recession, reflecting the combination of low inflation and downward rigidity in nominal wages. The overall picture of labor market adjustments during this crisis therefore stands in sharp contrast with past crisis episodes, during which significant increases in unemployment were generally combined with increasing informality and a sharp fall in real wages.

Common Patterns, Surprises & Puzzles

Behind these general patterns, substantial differences across countries remain. Unemployment rose relatively rapidly in some countries, such as Chile and Mexico, while in Brazil and Peru it returned to pre-crisis levels rather quickly. Another common trend is that the crisis had a differential impact across genders, hitting males harder than females. While labor force participation remained relatively stable overall, the share of female workers increased relative to males. Hence, the crisis did not reverse the trend towards closing the gap between male and female participation rates. In the countries studied, with the exception of Colombia and Mexico, men became unemployed proportionally more than women. While the reasons behind the better labor market performance remain to be studied, several factors may have played a role. The recent shock was transmitted mainly through the trade channel, thus affecting primarily the relatively land- and capital-intensive tradable sectors. In addition, the domestic policy environment has also changed: Sounder macro-financial policy frameworks and timely finance from multilateral institutions allowed the implementation of counter-cyclical fiscal policies that helped dampen the unemployment response. Finally, specific labor market policies, such as temporary employment programs and employment subsidies, may have also contributed to mitigating the impact of the external shock.

From Global Collapse to Recovery

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Office of Regional Chief Economist

Adjustments in employment, unemployment, and labor force participation5 In the last quarter of 2008, the world economy entered into the worst recession since the Great Depression. As discussed in Appendix I.A of the Part I of this report, the Latin America and the Caribbean (LAC) region’s economic performance during this crisis was better than in most of its own past downturns, and than in other emerging regions. Nonetheless, some of the pains of a recession were unavoidable. While the consequences of the crisis on labor markets around the world are still unfolding, it is clear that the impact is quite large. In Eastern Europe, the unemployment rate increased by 2 percentage points (pp) during 2009 while it grew by 2.4 pp on average in the developed world, with the largest increases in countries such as Ireland (10pp since 2008Q1) and Spain (9pp within the same period). In LAC, the unemployment rate rose by 1.2 pp, from 7 percent in 2008 to 8.2 percent in 2009, according to the latest estimates, implying that the number of the unemployed increased by 3.5 million to a total of 22.5 million by the end of the 2009 (ILO, 2010). In spite of this general pattern, both the level and the change in unemployment rates varied widely across countries. Encouragingly, unemployment started to fall in some countries starting in 2009Q2, but it is still too early to tell if this favorable development constitutes a change in trend. It might instead simply reflect a seasonal pattern, as employment in the region typically rises in the second half of the year. Employment in most LAC countries started to contract after the fourth quarter of 2008 (2008Q4). Thus, Ar-

gentina and Brazil experienced a decline in employment rates of around 1pp but quickly bounced back in 2009Q3 to pre-recession levels. Chile also experienced a sharp decline in employment but it had not rebounded by 2009Q3. In other LAC countries the labor market response actually began earlier. This was, for example, the case of Mexico and Peru. Whereas in Mexico the employment rate fell by 2.1 pp from 2008Q1 to 2009Q1, employment declined by 1.6 pp in Peru over the same period.6 The unemployment rate is affected both by labor supply and labor demand forces. During downturns, labor demand typically falls while the effect of a recession on the supply for labor is in principle ambiguous. Two opposite forces operate on the supply of labor and, hence, on the degree of labor force participation during recessions. On the one hand, the prospects of finding a job shrink as the unemployment rate increases, hence reducing the incentives for actively looking for a job. On the other hand, the reduction of employment, hours worked, or real wages among the breadwinners of the family might provide an incentive for the females and youth in the family (who are traditionally less attached to the labor market) to search for a job.7 The final impact on overall labor force participation rates depends on the relative strengths of these forces, and of the generosity and coverage of safety nets in the economy, which might alleviate the welfare consequences of unemployment among some of the members of the household. In LAC, the relative paucity of functional unemployment insurance schemes tends to strengthen incentives to remain in the job search, including in the informal sector. What was the actual net effect of these forces in LAC during the crisis?

This section draws on data from Argentina, Brazil, Chile, Colombia, Mexico, and Peru, for which aggregate labor market data are available up to the third quarter of 2009. 6  For an early assessment of the impact of the crisis on labor markets in the LAC region, see Freije-Rodríguez and Murrugarra (2009) 7  Labor force participation varies substantially by gender among LAC countries. On average, female participation rates are lower than those of males, although these differences are quite heterogeneous across LAC countries. Participation rates for females in the region are lowest in Chile and Mexico (slightly above 40 percent) and highest in Peru (around 60 percent). In Colombia, Argentina and Brazil they are rapidly approaching 50 percent. There is also quite a lot of heterogeneity across countries in the participation of men, with a relatively low rate in Brazil, around 66 percent, that is, more than 10 pp below the rates in the countries with the highest rates in our sample, Mexico and Peru. 5 

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From Global Collapse to Recovery

The World Bank

The overall participation rate remained relatively constant in most countries, but female participation increased relative to males. During the global downturn, overall participation rates have barely changed in Brazil, Chile, Mexico and Peru. The largest exception to this pattern was observed in Colombia, which experienced a net increase of 2.5 pp during 2008Q3– 2009Q3, followed by Argentina (a 1 pp increase during the same period). While the actual response of male and female participation rates to the recession varied across LAC countries, the pre-existing trend toward the narrowing of gender gap in labor force participation was either maintained or even accentuated during the crisis. This was because, similarly to previous crisis, male participation rates tended to decline while female participation rates tended to increase; or in the countries where both increased in tandem, female participation tended to increase more (see Figure 16). Even with rising female participation relative to males, the unemployment rate of males rose relative to females in the LAC-6 (Figure 17). Male unemployment rates increased the most in Chile, by 2.9 pp yearon-year (yoy) in 2009Q3, followed by Argentina and Mexico (2.2 and 1.4 pp, respectively). Male unemployment remained relatively stable in Peru whereas

it increased mildly in Brazil and Colombia (around 0.5 pp). The increase in female unemployment rates, by contrast, has been weaker. Again, Chile experienced a relatively large increase in female unemployment in 2009Q3 (1.6 pp yoy)—which is however only about half the increase in the rate of male unemployment. Female unemployment declined mildly in Brazil, and more sharply in Peru (by 1.7 pp yoy) to reach 9.5 percent (the lowest in the last 5 years). The outlier was Mexico, where female unemployment rates rose by 2.4 pp. The effect of the crisis on the gender composition of employment and unemployment is likely related to its differential effect across the manufacturing and service sectors. As shown in Appendix I.A of Part 1, countries with higher trade exposure and specialized in manufacturing exports experienced larger growth collapses. Hence, the external shock was transmitted to the region through a fall in the demand for tradable goods. It is well known that manufacturing traded sectors tend to employ males in a larger proportion than females. Hence, a shock hitting those sectors is likely to have a larger impact on males. Figure 18 illustrates that the reduction in employment was strongest in manufacturing sectors during the recession. It depicts the variation in the share of workers employed in

Figure 16  Participation Rate by Gender in Selected LAC Countries A.  Male Population 85%

B.  Female Population 85%

Peru

Mexico

75%

75%

Argentina Chile

Colombia

65%

65%

Brazil

Peru

55%

55%

Argentina

45%

45%

Brazil

Colombia Mexico Chile

Sep-09

Mar-09

Sep-08

Mar-08

Sep-07

Mar-07

Sep-06

Mar-06

Sep-05

Mar-05

Sep-09

Mar-09

Sep-08

Mar-08

Sep-07

Mar-07

Sep-06

Mar-06

35% Sep-05

Mar-05

35%

Source: International Labor Organization

PART II  Labor Markets in LAC During the 2009 Downturn

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Office of Regional Chief Economist

Figure 17  Unemployment Rate by Gender in Selected LAC Countries A.  A. Male Population

B.  B. Female Population

20%

20%

18%

18%

16%

16%

14%

14%

12%

12%

Argentina

10%

10%

Colombia

Peru

Chile Mexico

4%

Mexico

2%

2% Sep-09

Mar-09

Sep-08

Mar-08

Sep-07

Mar-07

Sep-06

Mar-06

Sep-05

Mar-05

Sep-09

Mar-09

Sep-08

Mar-08

Sep-07

Mar-07

Sep-06

Mar-06

0% Sep-05

Mar-05

Brazil Peru

6%

Brazil

Chile

4% 0%

Argentina

8%

8% 6%

Colombia

Figure 18  Change in Employment Levels by Activity A.  Industry

B.  Services

in Percentage Points

in Percentage Points 2.5%

2.5% Female

2.0%

Male

2.0%

1.5%

1.5%

1.0%

1.0%

0.5%

0.5%

0.0%

0.0%

–0.5%

–0.5%

–1.0%

–1.0%

–1.5%

–1.5%

–2.0%

–2.0%

–2.5%

–2.5% Argentina

Brazil

Chile

Mexico

Female

Argentina

Brazil

Chile

Male

Mexico

Note: Differences in the change of the share of manufacturing and services employment share between June 2009 to June 2008 and June 2008 to June 2007. Source: Cho and Newhouse (2010).

manufacturing and services in the 2008Q2–2009Q2 period compared to the preceding year (2007Q2– 2008Q2) in Argentina, Brazil, Chile and Mexico.8 We observe that the share of employment in services has increased faster relative to manufacturing during the recession than during the last year of expansion in all

major countries, except for Argentina. Hence, in contrast with previous recessions in the region, when the external sector actually helped dampen the labor market response to the shock, these numbers suggests an asymmetric effect of the downturn in global demand for tradable versus non tradable goods in LAC.

The double difference is intended to isolate the change in shares associated with the recession from the secular structural change towards the service sector that is taking place in every country.

8 

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No clear signs of a crisisinduced expansion in informal employment Not only were unemployment increases relatively mild in most countries, but rises in informality—a typical byproduct of economic downturns in Latin America— were conspicuous only by their absence. The deterioration in economic activity in LAC labor markets has traditionally led to an increase in informal employment, or in hidden unemployment. Although informal employment had progressively lost ground relative to formal employment in the years preceding the global crisis, one might have expected the crisis to have reversed this trend, especially considering the countercyclical nature of informal unemployment and the dearth of formal hiring observed in previous recessions (Bosch and Maloney, 2008). The indicators

Zooming in on the dynamics of labor markets: the cases of Argentina and Brazil

Figure 19  Type of Labor Contracts in Selected LAC Countries Share of Workers Relative to the Total Number of Employees Change from 2008 to 2009, in Percentage Points 7 6

With Contract

With Health Insurance

5 4 3 2 1 0 –1 –2 –3

Argentina

Brazil

Colombia

Ecuador

Mexico

available so far, however, do not suggest a reversal of the rising trend in the formal employment share, although the rate of increase in formality did appear to decelerate during the crisis.9 The evolution of formal employment during this global crisis can be gauged by looking at the share of workers with a labor contract and that of workers with health insurance. The share of formal employment in total employment (using having a labor contract as a measure of formality) kept on rising during the crisis in all countries but Colombia: between 2008Q2 and 2009Q2 in Brazil (by 3.4 pp), Mexico (1.4 pp), and Peru (3.1 pp) (Figure 19). When we use workers with access to health insurance as an indicator of formality the message is less clear. Formal employment declined considerably in Mexico (by 1.8 pp) and Colombia (by 1.4 pp), but increased sharply in Argentina (by 3.5 pp) and Peru (by 6.6 pp).

Peru

Note: For Argentina and Brazil, LCRCE Staff calculations based on Households Surveys. When the bars are not shown in the graph is because the information for that specific country is not available. Source: International Labor Organization.

We now examine the behavior of the different segments of the active labor force—formal employment, informal employment, unemployment and self-employment— during the business cycle in Argentina and Brazil, using quarterly information for the period 1991–2009.10 Figure 20 depicts their evolution in Argentina and Brazil. The shaded areas in the figures represent recessions—as defined in Appendix II.A. The message from the previous section is reinforced. Formal employment stagnated somewhat with respect to the expansion period, but it did not lose relative weight in favor of informality as it did during previous recessions. In Argentina, the unemployment rate increased rapidly in the previous downturn (1998Q2–2002Q1),

There is no consensus on the best definition of informality (Perry et al., 2007) and data availability limitations preclude us from presenting a full picture of the behavior of the informal segment of the labor market (under alternative definitions) during this crisis. 10  The quarterly data on the different segments of the labor market spans from 1995Q2 to 2009Q3 in Argentina, and from 1991Q1 to 2009Q4 in Brazil. Formal employment in Argentina is defined as the share of workers having access to both health insurance and a pension benefit through their jobs. In the case of Brazil, formal employees are defined as those with “carteira de trabalho assinada,” a signed labor card that gives access to social insurance or social protection. Lastly, we consider a residual employment condition, which we call “other employees” and comprises owners of firms and unpaid employees. 9 

PART II  Labor Markets in LAC During the 2009 Downturn

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Office of Regional Chief Economist

reaching a peak close to 21 percent in 2002Q3 before declining sharply (see Figure 20.A). The initial absorption of this large number of unemployed workers coincided with a massive increase of the share of informal employment, which rose by 9 pp between 2002Q3 and 2004Q3. The formal sector remained stubbornly closed to new hires with the result that the share of formality continued a downward trend for more than a year after the recession. When the recovery strengthened, starting in the second half of 2003, the formal sector reactivated and started absorbing unemployed and informal workers. At the start of the current downturn, by contrast, the upward trend in formal employment in Argentina leveled off somewhat but did not decrease. Interestingly, the share of informal employment continued to lose ground during this period (by 0.9 pp) in favor of formal employment and the self-employed. This finding reflects some degree of substitution between informality and self-employment during the last recession in Argentina.

Brazil exhibits an upward trend in formal employment since the second half of 2004, which led to a net cumulative gain of the share of formal workers of 8 pp by 2009Q4 (Figure 20.B). This steady increase in formal employment was not reversed by the crisis, although the share of informality declined at a slower pace in the second half of the 2000s (falling by only 0.7 pp in 2009). The share of self-employed increased by nearly 0.4 pp during 2009.

A milder labor market response to crisis this time around In sum, while unemployment did rise in the LAC-6 countries during the recent recession, these increases were relatively muted. Labor force participation rose, especially among females, and there were no clear signs of deterioration in the quality of employment, at least in terms of growing informality.11 Next, we investigate whether labor market responses during

Figure 20  Active Labor Force by Status A.  Argentina

B.  Brazil

60%

60%

50%

50% Formal Employee

40%

Informal Employee

30%

Self-Employed

20%

20%

Unemployed

Informal Employee Self-Employed

Unemployed

10%

Employed. Others

Employed. Others

Oct-08

Jul-07

Jan-05

Apr-06

Jul-02

Oct-03

Apr-01

Jan-00

Oct-98

Jul-97

Apr-96

Jan-95

Sep-93

Jun-92

Apr-09

Jan-08

Oct-06

Jul-05

Apr-04

Jan-03

Oct-01

Jul-00

Apr-99

Jan-98

0% Sep-96

0% Jun-95

30%

Mar-91

10%

Formal Employee

40%

Note: Shaded areas are recessions, as defined in Appendix II.A. Source: LCRCE calculations based on Households Surveys. For Argentina, Encuesta Permanente de Hogares (EPH) y Encuesta Permanente Continua de Hogares (EPHC), for Brazil, Pesquisa Mensal de Emprego (PME).

In an earlier assessment, Ferreira and Schady (2009) have a relatively benign view of the effects of the global crisis on Latin American labor markets.

11 

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the current downturn were similar to those in previous recessions.12 The main conclusion of our analysis is that, controlling for the size of the downturn, the rise in unemployment this time around was significantly smaller than in previous crisis episodes. This result is even more surprising considering that average real wages (in the economy as a whole) did not fall during this recession—given the combination of low inflation and downward rigidity in nominal wages—whereas they fell sharply in previous crises (on account of significant inflation spikes). Let us now consider some of the details behind this result. Figure 21.B illustrates the fact that the rise in unemployment during previous recessions substantially exceeded that observed in the current one. Argentina and Chile experienced the largest surges in the rate of

unemployment in previous recessions, with increases of 8.3 pp and 5.6pp, respectively. In contrast, unemployment rose only mildly during the current recession —by 0.4 pp and 2.3 pp in Argentina and Chile, respectively. Note also that even in Mexico, which experienced the sharpest GDP contraction in the region this time around, the unemployment response was less than half that observed during the Tequila crisis, i.e., between 1994Q4 and 1995Q3. The milder unemployment response this time around could be attributed either to softer GDP contractions (than in previous crises) or to a weaker link between the change in economic activity and the change in unemployment (that is, to a lower elasticity of unemployment to output). First, GDP did contract by less during the current crisis, but not in all countries (Figure 21.A). Argentina, Colombia and Mexico experienced larger contractions in economic activity

Figure 21  GDP Growth and Change in the Unemployment Rate During Recessions A.  GDP Growth (%)

B.  Change in Unemployment (p.p.)

Current Recession

Mexico

Previuos recession

Colombia

–30

–25

–20

–15

–10

–5

Chile

Brazil

Brazil

0

Previous recession

Colombia

Chile

Argentina

Current Recession

Mexico

Argentina 0

2

4

6

8

10

Note: Previous recession periods are: Argentina (1998.Q4–2002.Q2); Brazil (1997.Q4–1998.Q2); Chile (1998.Q3–1999.Q4); Colombia (1998.Q3–1999.Q4); and Mexico (1995.Q1–1996.Q1). Current recession periods are: Argentina (2008.Q3–2009.Q2); Brazil (2008.Q4– 2009.Q2); Chile (2008.Q3–2009.Q3); Colombia (2008.Q3–2009.Q2); and Mexico (2008.Q2–2009.Q2). Source: LCRCE Staff calculations based on National Statistical Institutes data.

The samples used are constrained by the availability of quarterly unemployment data. We use the Harding and Pagan (2002) adaptation of the Bry-Boschan algorithm (BBQ) to date recessions from quarterly GDP series in Argentina, Brazil, Chile, Colombia, and Mexico. A more detailed description of the algorithm is provided in Appendix II.A. As a result, the measures of GDP contraction, i.e., of decreases in the level of GDP, used in this part of the report do not coincide with those in Part I, where growth collapse is defined simply as the difference in the annual GDP growth rate between 2007 and 2009.

12 

PART II  Labor Markets in LAC During the 2009 Downturn

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Office of Regional Chief Economist

during their respective previous downturns compared to the recent global crisis. In the case of Argentina, the crisis of 1998–2002 was associated with a dramatic collapse of GDP in real terms (28 percent), while during the current episode GDP contracted by almost 10 percent. Mexican GDP fell in real terms by nearly 15 percent during the Tequila crisis, while it shrank by 12 percent during 2008–2009. In Colombia differences are marked, but the contractions are overall smaller (7 percent during the previous recession vs. 1 percent during the global crisis). Brazil and Chile instead suffered a similar contraction in GDP during the current crisis compared to certain previous episodes.

Figure 22  Sensitivity of Unemployment to Economic Activity Elasticity of Unemployment With Respect to GDP Growth 2.5 Previous recession Current Recession

2.0 1.5 1.0 0.5 0.0

Argentina

Brazil

Chile

Colombia

Mexico

Second, while there is a great deal of heterogeneity in the responses among the 5 LAC countries analyzed, it is clear that the rise in the unemployment rate (in percentage points) for each one percent contraction in GDP (i.e., the semi-elasticity of unemployment to output) was significantly larger in past downturns compared to the current one (Figure 22). For instance, the semi-elasticity of unemployment to output has halved in Chile, from 1 in the previous recession to 0.5 during the last episode. A similar reduction is observed in Mexico, although the semi-elasticities there are smaller (0.25 during the Tequila crisis vs. 0.12 during the current one). In Argentina and Brazil, the semi-elasticities of unemployment were 6 and 3 times larger in past downturns, respectively, than in the current one.

tion in Colombia merit further study. Other elements might be at play behind the sharp output elasticity of unemployment in Colombia. Colombia has one of the most binding minimum wages in the region, and previous studies have established their negative impact on employment (Cunningham, 2007). During the recession, these negative effects on employment might have exacerbated.

The sole exception is Colombia, where the semi-elasticity of unemployment to output during the previous recession was about one third the one observed in the recent downturn. The Colombian result might be related to the massive increase in labor force participation observed during the downturn. During 2008Q3 and 2009Q2, overall participation increased by 2.5 pp in Colombia while in the other four countries it barely changed. The forces behind this increase in participa-

Aggregate wage behavior fails to explain the relatively muted response of unemployment to output contraction among LAC countries during the current global crisis. While in previous recessions average real wages in the whole economy fell rapidly due to high inflation, this time around they exhibited an upward trend, pointing towards downward rigidity in nominal wages in a new LAC context of low inflation.13 In Argentina, real wages for males (formal and informal workers)

Note: Previous recession periods are: Argentina (1998.Q4–2002. Q2); Brazil (1997.Q4–1998.Q2); Chile (1998.Q3–1999.Q4); Colombia (1998.Q3–1999.Q4); and Mexico (1995.Q1–1996.Q1). Current recession periods are: Argentina (2008.Q3–2009.Q2); Brazil (2008.Q4–2009.Q2); Chile (2008.Q3–2009.Q3); Colombia (2008.Q3–2009.Q2); and Mexico (2008.Q2–2009.Q2). Source: LCRCE Staff calculations based on National Statistical Institutes data.

Unfortunately, we only had access to quarterly data on average wages for Argentina and Brazil. Instead, most countries publish data on compensation per employee in the industrial sector, which are shown in the case of Mexico. In Figure 2.8 recessions are represented by the shaded areas, and we have set the CPI and wage index to 100 for the first quarter of the recession to highlight the behavior of prices during recessions.

13 

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From Global Collapse to Recovery

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declined sharply in the previous recession, especially after the convertibility was abandoned and inflation spiked at the end of 2001. During the current recession, real wage behavior has been apparently different, although the interpretation of the data is clouded by well-know concerns with an underestimation of the CPI. After a moderate decline in the first quarter of the recession, reported real wages returned to their pre-recession upward trend (Figure 23.A and Figure 23.B).14 In Brazil, after an initial upward spike real wages declined sharply throughout the 1997–1998 recession, while they showed an upward trend during the current turmoil (Figure 23.C and Figure 23.D). The acceleration of inflation in Mexico during 1995–1996 led to a major downward adjustment in real wages (18 pp in a year), and while there are signs of wage moderation during the current crisis there was no clear downward adjustment (Figure 23.E and Figure 23.F). The milder response of unemployment to the decline in real economic activity during the global crisis compared to previous recessions constitutes an apparent puzzle that deserves further research, especially since we observe, if anything, stronger wage rigidities in the recent past rather than in previous recessions with the available data. What explains the different behavior this time around? Among the many conjectures, it could be argued first that the nature of the recent shock is different. Whereas the current crisis originated outside the region, previous recessions were either home-brewed or externally generated but magnified by internal weaknesses. Previous recessions affected most sectors of economic activity while the current global shock was transmitted mainly through the external sector, which is typically (land or) capital intensive. Moreover, to the extent that this recession was perceived as a temporary phenomenon, firms in sectors where training and/ or firing are costly (i.e., formal sectors) might have opted for labor hoarding rather than layoffs.

Another conjecture could be that the rising formal employment in the second half of the 2000s might have reduced the volatility of LAC labor markets inasmuch as it came with increasing job protection. If this is the case, one might expect a slower job recovery this time around compared to previous recessions. This would be because firing costs/restrictions can be expected to reduce also hiring when conditions turn favorable, as firms anticipate costs associated with future layoffs (Bentolila and Bertola, 1990). Lastly, countercyclical fiscal policies, to the extent that they were implemented in LAC, might have supported employment, for example, through spending on public works. In addition, efforts to prevent labor shedding were an important ingredient of stimulus packages in some LAC countries. Overall, it is estimated that the region’s government had planned to invest an additional US$25 billion in 2009, which would imply a 20 percent increase in public spending on infrastructure above the original targets (Schwartz, Andrés, and Dragoiu, 2009). Although it is premature to assess the effectiveness of these programs on employment, they might have helped mitigating the unemployment response. Regarding labor market policies, Appendix II.B provides a description of policy interventions specifically designed to cope with the effects of the international financial crisis on labor markets in selected LAC countries. We conclude this section with a closer look at the evolution of formal and informal employment and wages in Argentina and Brazil. Compared to Figure 20 presented above, we focus our discussion here on the comparative performance of the shares of formal and informal employment in the active labor force during the recessionary periods associated to the current crisis vis-à-vis previous crises (Figure 24).15 Formal employment decreased significantly in Argentina and Brazil in previous

The corresponding graphs for females present a qualitatively similar pattern. We prefer to show the evolution of male wages since it is well known that compositional changes in the labor force across the business cycle are more pronounced for females than for males. 15  As before, in Argentina the point of comparison is the recessionary period from 1998Q2 to 2002Q2 associated to the financial crisis. In Brazil we identify two previous recessionary periods, 1997Q4 to 1998Q2 and 1999Q4 to 2002Q2. 14 

PART II  Labor Markets in LAC During the 2009 Downturn

29

Office of Regional Chief Economist

Figure 23  Evolution of Real Wages and CPI (Males) B.  Argentina

Previous Crisis Index Jun-98 = 100 Previous Crisis Previous Crisis Index Jun-98 = 100 Index Jun-98 = 100

Current Crisis Index Jun-08 = 100 Current Crisis Current Crisis Index Jun-08 = 100 Index Jun-08 = 100

Jun-09 Jun-09 Jun-09 Dec-09 Dec-09 Dec-09

Mar-09 Mar-09 Mar-09 Sep-09 Sep-09 Sep-09

Dec-08 Dec-08 Dec-08 Mar-09 Mar-09 Mar-09

Dec-08 Dec-08 Dec-08

Jun-09 Jun-09 Jun-09

Jun-08 Jun-08 Jun-08

Sep-08 Sep-08 Sep-08

Sep-08 Sep-08 Sep-08

Mar-08 Mar-08 Mar-08

Jun-08 Jun-08 Jun-08

Dec-07 Dec-07 Dec-07

Sep-07 Sep-07 Sep-07

CPI Real Compensation CPIper Employee-Industry Real Compensation per Employee-Industry Real Compensation per

Dec-09 Dec-09 Dec-09

Sep-09 Sep-09 Sep-09

Employee-Industry

Jun-09 Jun-09 Jun-09

Jun-96 Jun-96 Jun-96

Mar-96 Mar-96 Mar-96

Employee -Industry

Dec-95 Dec-95 Dec-95

Sep-95 Sep-95 Sep-95

Jun-95 Jun-95 Jun-95

Mar-95 Mar-95 Mar-95

Dec-94 Dec-94 Dec-94

Sep-94 Sep-94 Sep-94

Real Compensation per Employee -Industry Real Compensation per Employee -Industry Real Compensation per

CPI

Mar-09 Mar-09 Mar-09

CPI

Dec-08 Dec-08 Dec-08

CPI

Current Crisis F.  Mexico Index Dec-07 = 100 Current Crisis Current Crisis Index Dec-07 = 100 Index Dec-07 = 100

Sep-08 Sep-08 Sep-08

CPI

180 180 170 180 170 160 170 160 150 160 150 140 150 140 130 140 130 120 130 120 110 120 110 100 110 100 90 100 90 80 90 80 70 80 70 70

Mar-08 Mar-08 Mar-08

Mar-00 Mar-00 Mar-00

Dec-99 Dec-99 Dec-99

Jun-99 Jun-99 Jun-99

Sep-99 Sep-99 Sep-99

Mar-99 Mar-99 Mar-99

Dec-98 Dec-98 Dec-98

Jun-98 Jun-98 Jun-98

Sep-98 Sep-98 Sep-98

Mar-98 Mar-98 Mar-98

Dec-97 Dec-97 Dec-97

Jun-97 Jun-97 Jun-97

Sep-97 Sep-97 Sep-97

Mar-97 Mar-97 Mar-97

Sep-96 Sep-96 Sep-96

Dec-96 Dec-96 Dec-96

Jun-96 Jun-96 Jun-96

Mar-96 Mar-96 Mar-96

Previous Crisis E.  Mexico Index Dec-94 = 100 Previous Crisis Previous Crisis Index Dec-94 = 100 Index Dec-94 = 100

Jun-08 Jun-08 Jun-08

CPI CPI

D.  Brazil

Current Crisis Index Sep-08 = 100 Current Crisis Current Crisis Index Sep-08 = 100 Index Sep-08 = 100

Mar-08 Mar-08 Mar-08

CPI

115 115 110 115 110 105 110 105 100 105 100 Real Mean Wage 95 Real Mean Wage 100 95 Real Mean CPI Wage 90 95 CPI 90 CPI 85 90 85 80 85 80 80 Mar-07 Mar-07 Mar-07

Real Mean Wage Real Mean Wage

Jun-94 Jun-94 Jun-94

180 180 170 180 170 160 170 160 150 160 150 140 150 140 130 140 130 120 130 120 110 120 110 100 110 100 90 100 90 80 90 80 70 80 70 70

Real Mean Wage

Mar-94 Mar-94 Mar-94

115 115 110 115 110 105 110 105 100 105 100 95 100 95 90 95 90 85 90 85 80 85 80 80

Real Mean Wage

Dec-07 Dec-07 Dec-07

C.  Brazil

Previous Crisis Index Sep-97 = 100 Previous Crisis Previous Crisis Index Sep-97 = 100 Index Sep-97 = 100

Real Mean Wage

Dec-07 Dec-07 Dec-07

Jun-97 Jun-97 Jun-97 Sep-97 Sep-97 Sep-97 Dec-97 Dec-97 Dec-97 Mar-98 Mar-98 Mar-98 Jun-98 Jun-98 Jun-98 Sep-98 Sep-98 Sep-98 Dec-98 Dec-98 Dec-98 Mar-99 Mar-99 Mar-99 Jun-99 Jun-99 Jun-99 Sep-99 Sep-99 Sep-99 Dec-99 Dec-99 Dec-99 Mar-00 Mar-00 Mar-00 Jun-00 Jun-00 Jun-00 Sep-00 Sep-00 Sep-00 Dec-00 Dec-00 Dec-00 Mar-01 Mar-01 Mar-01 Jun-01 Jun-01 Jun-01 Sep-01 Sep-01 Sep-01 Dec-01 Dec-01 Dec-01 Mar-02 Mar-02 Mar-02 Jun-02 Jun-02 Jun-02 Sep-02 Sep-02 Sep-02 Dec-02 Dec-02 Dec-02 Mar-03 Mar-03 Mar-03 Jun-03 Jun-03 Jun-03 Sep-03 Sep-03 Sep-03 Dec-03 Dec-03 Dec-03 Mar-04 Mar-04 Mar-04

Real Mean Wage

Real Mean Wage

CPI

Jun-07 Jun-07 Jun-07

Real Mean Wage

CPI

Sep-07 Sep-07 Sep-07

Real Mean Wage

CPI

Jun-07 Jun-07 Jun-07

CPI

Sep-07 Sep-07 Sep-07

CPI

Mar-07 Mar-07 Mar-07

CPI

150 150 140 150 140 130 140 130 120 130 120 110 120 110 100 110 100 90 100 90 80 90 80 70 80 70 60 70 60 60

Jun-07 Jun-07 Jun-07

150 150 140 150 140 130 140 130 120 130 120 110 120 110 100 110 100 90 100 90 80 90 80 70 80 70 60 70 60 60

A.  Argentina

Note: The graph depicts the evolution of quarterly average male real wages for the whole economy (all sectors) and the CPI index around recession periods for Argentina and Brazil. For Mexico, wage data refers to average compensation per employee in the manufacturing sector. Source: LCRCE calculations for Argentina based on Encuesta Permanente de Hogares (EPH) and Encuesta Permanente Continua de Hogares (EPHC) and for Brazil based on Pesquisa Mensal de Emprego (PME). For Mexico, Banco de México and INEGI.

30

From Global Collapse to Recovery

The World Bank

Figure 24  Changes in Active Labor Force by Status During Recessions (Percentage Point Variation Between Peak and Trough) A.  Argentina

B.  Brazil

1.0 Previous Recession (98q2–02q1)

0.5

1.0

Current Recession (08q3–09q1)

0.0

0.5

Previous Recession (97q3–98q1) Previous Recession (99q3–00q1) Current Recession (08q3–09q1)

–0.5 –1.0

0.0

–1.5 –2.0

–0.5

–2.5 –3.0

–1.0

–3.5 –1.5

–4.0 Formal Employment

Formal Employment

Informal Employment

Informal Employment

Source: LCRCE calculations based on Households Surveys: Pesquisa Mensal de Emprego (PME); Encuesta Permanente de Hogares (EPH) and Encuesta Permanente Continua de Hogares (EPHC).

crises while it slightly increased in both countries during the current downturn. In contrast, informality either increased or remained constant in previous crises while it has declined in Argentina and Brazil this time around. Counter-cyclical fiscal policies, to the extent that they targeted public works and contracts with firms in the formal sector, might help explaining the differential behavior across the recessions. Real wages in the formal and informal sector in Argentina and Brazil might also help to shed some light on the different behavior of LAC labor markets during the current recession. In Argentina, the sharp decline of relative wages of informal with respect to formal workers in previous crises (especially after exiting the convertibility program) may help understand the different behavior of quantities during the recession. Instead, the lack of dynamism of informal employment during the current downturn might be related to wage setting: wages of informal workers have grown as fast as the wages of formal employees (Figure 25.A and Figure 25.B). In contrast, we do not find a differential wage behavior across crises episodes in Brazil (Figure 25.C and Figure 25.D). During the two recessions, wages of formal employees decline relative to wages of informal workers.

Final remarks Our exploratory assessment of the evolution of labor market aggregates in selected LAC countries during the recent crisis shows that labor markets were not hit as hard as in previous recessions. Neither quantities— unemployment, employment—nor wages suffered as much as in the past, while indicators of labor quality such as the share of formal employment continued growing, albeit at a slower pace. While the differential impact of the crisis with respect to past episodes deserves further study, it may be explained partly by the nature of the external shocks. The greater ability of the region to withstand shocks (due to sounder macrofinancial policy frameworks) may also have played an important role. Counter-cyclical fiscal policies were implemented to one extent or another in most countries studied here, which may have dampened the initial unemployment response. It is also possible that labor market policy responses may have helped mitigate the impact of the shocks on labor markets. A thorough evaluation of the effectiveness of these policies and their role in dampening the labor market response in the region constitutes an important issue that warrants additional research.

PART II  Labor Markets in LAC During the 2009 Downturn

31

Office of Regional Chief Economist

Figure 25  Evolution of Real Wages and CPI (males) by Status B.  Argentina

Previous Crisis Index Jun-98 = 100 Previous Crisis Index Jun-98 = 100

Current Crisis Index Jun-08 = 100 Current Crisis Index Jun-08 = 100

160 CPI

160 140

Real Wages Formal Employee

120 100

100 80

Real Wages Formal Employee

100 80

Real Wages CPI Informal Employee Real Wages Informal Employee

60 40

40

40

Dec-07 Dec-07

Real Wages Informal Employee

Sep-07 Sep-07

60 40

Jun-07 Jun-07

80 60

Mar-07 Mar-07

Real Wages Informal Employee

Jun-97 Jun-97 Sep-97 Sep-97 Dec-97 Dec-97 Mar-98 Mar-98 Jun-98 Jun-98 Sep-98 Sep-98 Dec-98 Dec-98 Mar-99 Mar-99 Jun-99 Jun-99 Sep-99 Sep-99 Dec-99 Dec-99 Mar-00 Mar-00 Jun-00 Jun-00 Sep-00 Sep-00 Dec-00 Dec-00 Mar-01 Mar-01 Jun-01 Jun-01 Sep-01 Sep-01 Dec-01 Dec-01 Mar-02 Mar-02 Jun-02 Jun-02 Sep-02 Sep-02 Dec-02 Dec-02 Mar-03 Mar-03 Jun-03 Jun-03 Sep-03 Sep-03 Dec-03 Dec-03 Mar-04 Mar-04

80 60

CPI

C.  Brazil

D.  Brazil Current Crisis

Previous Crisis Index Sep-97 = 100 Previous Crisis Index Sep-97 = 100

115 110 115

Index Sep-08 = 100 Current Crisis Index Sep-08 = 100

115 110 115

105 110

Real Wages Informal Employee

105 110

100 105

Real Wages Informal Employee

100 105

95 100 90 95 85 90

CPI

Real Wages Formal Employee

CPI

Real Wages Formal Employee

80 85

Real Wages Informal Employee Real Wages Formal Employee

Real Wages Informal Employee

Real Wages Formal Employee CPI

95 100 90 95

CPI

85 90

Dec-09 Dec-09

Sep-09 Sep-09

Jun-09 Jun-09

Mar-09 Mar-09

Dec-08 Dec-08

Sep-08 Sep-08

Jun-08 Jun-08

Mar-08 Mar-08

Dec-07 Dec-07

Sep-07 Sep-07

Jun-07 Jun-07

80

Mar-07 Mar-07

Mar-00 Mar-00

Dec-99 Dec-99

Jun-99 Jun-99

Sep-99 Sep-99

Mar-99 Mar-99

Dec-98 Dec-98

Jun-98 Jun-98

Sep-98 Sep-98

Mar-98 Mar-98

Dec-97 Dec-97

Jun-97 Jun-97

Sep-97 Sep-97

Mar-97 Mar-97

Sep-96 Sep-96

Dec-96 Dec-96

Jun-96 Jun-96

80 85 Mar-96 Mar-96

80

Jun-09 Jun-09

120 100

Mar-09 Mar-09

Real Wages Formal Employee Real Wages Formal Employee

140 120

Dec-08 Dec-08

140 120

Sep-08 Sep-08

CPI

Jun-08 Jun-08

160 140

Mar-08 Mar-08

160

A.  Argentina

Source: LCRCE Staff calculations based on Households Surveys. For Argentina, Encuesta Permanente de Hogares (EPH), and Encuesta Permanente Continua de Hogares (EPHC); for Brazil, Pesquisa Mensal de Emprego (PME).

32

From Global Collapse to Recovery

Appendix I.A

The Great Growth Collapse in 2009

The global financial crisis hit the world economy suddenly, severely, and in a synchronized fashion. No country was left unscathed. However, the growth consequences of the crisis vary considerably across countries. So far several explanations have been put forth and, although there is still no consensus on the relative importance of different factors in the international transmission of this crisis, it has been argued the cross-country differences in growth response at the onset of the crisis may reflect differences in: (i) the exposure to real and financial manifestations of the global shock, (ii) the institutional and macroeconomic framework in place, and (iii) the response engineered by policymakers. In other words, provided that all countries were hit by a global shock (similar in nature across countries), the differences in growth performance may reflect the cross-country variance in terms of resilience (external and macroeconomic vulnerabilities as well as other factors that might amplify shocks). This appendix investigates the relationship between the growth collapse at the onset of the crisis and pre-crisis characteristics of the domestic economy and its linkages to the rest of the world. The findings are presented in Table I.A and compared in light of recent empirical work. Our dependent variable is the change in the GDP growth rate in 2009 relative to 2007. Earlier attempts to characterize the crisis focus on measuring the severity of the crisis in its different financial and real manifestations (Rose and Spiegel, 2009a, b). These studies are unable to link the growth decline since the beginning of the crisis to either pre-existing conditions in the domestic economies (except for sharp rises in equity prices) or international trade and financial linkages. We conduct a regression analysis for a sample of 103 countries and find that output during the crisis was hit the hardest in advanced countries (see Table A). Controlling for income per capita, we estimate the link between the growth collapse in 2008–9 and its potential causes, as classified in the following groups: (a) trade and financial linkages, (b) macroeconomic and financial vulnerabilities, and (c) regulatory quality. Trade and financial linkages. The decline in growth performance was larger in countries with higher trade exposure, although no significant role for the composition of trade was found. On the other hand, recent evidence suggests that the growth collapse was deeper in countries with high shares of manufacturing exports (Berkmen et al. 2009; Lane and Milesi-Ferretti, 2010), but this effect ceases to be significant when the sample is restricted to emerging markets (Blanchard et al. 2010).

From Global Collapse to Recovery

33

Office of Regional Chief Economist

We fail to find a robust link between the overall measure of financial openness and the growth collapse. However, the structure of foreign assets and liabilities may have played a significant role. Table I shows that safer modes of integration (i.e., lower debt-to-equity ratios) were associated to milder growth declines. This finding may reflect the insulation properties against external shocks of this mode of integration (Lane and Milesi-Ferretti, 2010). Finally, Blanchard et al. (2010) show that countries with external finance vulnerabilities (i.e. higher short-term debt to GDP ratios) have also suffered larger growth collapses. Macroeconomic and financial vulnerabilities. Our evidence suggests that the growth collapse (if any) was milder in countries with ability to implement countercyclical policies and with lower pre-crisis inflation. However, we fail to find a robust role for the flexible exchange rate arrangements.

34

From Global Collapse to Recovery

Countries with financial vulnerabilities also tended to suffer a larger growth collapse. Table A shows that high pre-crisis credit growth and highly-leveraged economies (i.e., high loan-to-deposit ratios) faced sharper declines in growth. Existing evidence shows that this effect was particularly more severe among EU accession countries (Berkmen et al. 2009). Quality of the regulatory framework. Giannone et al. (2010) examines the relation between regulation quality and growth performance during the crisis. Although countries with deeper financial markets may be better prepared to cope with crisis episodes, the authors find that countries that adopted more marketfriendly policies (i.e., deregulated credit markets) were hit the hardest. However, the quality of regulation in credit markets ceases to explain the growth collapse if only emerging markets are analyzed (Blanchard et al. 2010).

The World Bank

Table I.A  Characterizing the Growth Collapse Dependent Variable: Growth Collapse between 2007 and 2009  

 

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

Openness Trade Openness (Export and Imports, % of GDP)

0.028*** 0.018* (0.009) (0.011)

Financial Openness (Foreign Assets and Liabilities, % of GDP)

–0.030 (0.178)

0.022 (0.013)

0.019 0.019** 0.020** 0.022** (0.011) (0.009) (0.008) (0.009)

0.097 (0.092)

Domestic Demand –0.078* (0.040)

Private Consumption (% of GDP) Composition of Trade Share of Natural Resource Exports (% of Total Exports)

–0.026 (0.029)

Share of Manufacturing Exports (% of Total Exports)

0.011 (0.027)

Structure of External Liabilities Equity-related Financial Openness (Assets and Liabilities, % of GDP)

–1.554 (0.937)

Debt-related Financial Openness (Assets and Liabilities, % of GDP)

0.861** (0.389)

International Reserves (% of GDP)

4.851 (3.404)

Resilience of Domestic Financial Systems   “Excess” Credit Growth   (Average 2006–7 vs. 2002–5)

16.02** (6.179)

  Loan to Deposit Ratios   (Ratio, 2007)

3.521** (1.548)

Macroeconomic Policies   Fiscal Pro-Cyclicality   (Correlation of Govt. Spending and GDP)

4.797*** (1.505)

  Inflation Rates   (Level of YoY CPI) Observations R-squared

0.396*** (0.128) 103

85

83

84

50

99

96

99

0.106

0.081

0.047

0.101

0.155

0.188

0.173

0.208

Robust standard errors are reported in brackets. All regressions include controls for GDP per capita (PPP measure). ***, **, and * indicate statistical significance at one, five, or ten percent, respectively.

APPENDIX I.A  The Great Growth Collapse in 2009

35

Appendix I.B

Characterizing the Global Recovery: How fast? What is driving it?

This appendix characterizes the main features of the current recovery from the global downturn of 2008–9 and contrasts this episode with previous recoveries from financial crises and global downturns. An exploratory econometric assessment of the forces driving the recovery is presented in Table I.B. We find robust evidence of a bounce-back effect: countries that suffered a larger collapse in GDP growth rates between 2007 and 2009 are expected to have a stronger recovery (see regression [1]). However, our estimates suggest that the recovery is not steeper than the recession. For example, Mexican real output growth declined by 9.9 percentage points (from 3.3 percent growth in 2007 to a contraction in economic activity of 6.5 percent in 2009), and our estimates suggest a cumulative growth surge of only 5.5 percent for the years 2010–11. It should be highlighted that these figures are based on current forecasts and can be altered significantly if the perspectives for global growth (and the US in particular for the Mexican example) change. In short, our estimations suggest—regardless of the econometric specification used—that the rebound in economic activity will be sluggish. This result is consistent with recoveries from financial crises as well as those from global downturns (Terrones et al. 2009). Weak and slow recoveries from these turmoil periods tend to reflect declining asset prices, decreased levels of investment, and weak credit growth. The current rebound in economic activity is only partly engineered by a recovery in trade flows—see regression [2]. The unconditional correlation suggests only a modest economic impact: an increase in total trade of 10 percentage points of GDP would lead to an increase in GDP growth of only 0.2 percent. Moreover, the boost from greater trade flows appears to be negligible when controlling for the bounce-back effect, suggesting that the trade channel might also reflect a bounce-back effect from the collapsed trade volumes in the last quarter of 2008. It should be noticed that the trade effect on the recovery is primarily driven by a rebound in the manufacturing sectors—see regression [3]. In comparison to past episodes, net exports have typically operated as an engine that pulls the economy out of the recession (especially from those caused by financial crises). However, this pull factor loses steam during global downturns, which is the current case. The evidence suggests that export growth is sluggish during global downturns due to a sharp decline in U.S. imports (Terrones et al. 2009). As noted in the main text, advanced economies and emerging markets quickly implemented policies to counteract the recessionary

From Global Collapse to Recovery

37

Office of Regional Chief Economist

effects of the global financial crisis. Our estimations show that the recovery was indeed stronger in countries with the ability to run countercyclical policies, while the floating exchange rate regimes did not seem to play a significant role. Terrones et al. (2009) find that stronger recoveries in industrial economies are also characterized by discretionary increases in government spending and reductions in nominal and real interest rates. However, the authors suggest that the stimulus engineered by the government becomes less effective if it compromises the sustainability of the fis-

cal position. Moreover, Cerra et al. (2009) add that monetary policy appears to have no significant effect on the strength of the recovery among developing countries and that floating rates have helped developing countries rebound from previous recessions. The main messages from our regression analysis are summarized in the last four columns of Table B. Controlling for the bounce-back effect and openness to trade, we analyze the effect of different components of aggregate demand separately on the strength of the

Table I.B.  Characterizing the Growth Recovery Dependent Variable: Expected Recovery in Growth Rates between 2009 and 2011 (1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

Bounce Back Effects Growth Collapse between 2007–2009 (Percentages)

0.557*** (0.073)

0.546*** 0.542*** 0.441*** 0.527*** 0.494*** 0.467*** (0.083) (0.075) (0.079) (0.084) (0.083) (0.083)

Openness Trade Openness (Export and Imports, % of GDP)

0.018** 0.000 0.000 (0.008) (0.006) (0.005)

0.003 (0.005)

 

 

0.002 (0.005)

0.001 (0.005)

 

 

0.000 (0.006)

Financial Openness (Foreign Assets and Liabilities, % of GDP) Composition of Trade Share of Manufacturing Exports (% of Total Exports)

0.022* (0.012)

 

Pull and Push Factors and Macroeconomic Policies Fiscal Pro-Cyclicality (Correlation of Govt. Spending and GDP)

-1.461* (0.814)

Increase in Government Consumption (2007 vs. 2009, % of GDP)

87.93*** (26.74)

Increase in Private Household Consumption 2007 vs. 2009 (% of GDP)

   

Increase in Investment (Capital Formation) 2007 vs. 2009 (% of GDP)

R-squared

  -2.596 (7.206)

  

Increase in Net Exports (2007 vs. 2009, % of GDP) Observations

 

    -11.39 (10.62)

 

13.02** (5.917)

81

75

68

74

70

71

71

71

0.684

0.104

0.665

0.645

0.711

0.638

0.656

0.669

Robust standard errors are reported in brackets. All regressions include controls for GDP per capita (PPP measure). ***, **, and * indicate statistical significance at one, five, or ten percent, respectively.

38

From Global Collapse to Recovery

The World Bank

recovery in economic activity. The results suggest that the recovery from the current global financial crisis is driven by a rebound in domestic demand, in particular by higher government consumption, and to a lesser extent net exports. Next, we conduct an event study analysis to examine whether the different components of aggregate demand have played a different role this time around in comparison to past recoveries from crises episodes (See Figures I.B.1–I.B.6).16 The decline in GDP growth rates has been sharper during the current global downturn among high-income countries (HICs) and the expectations of a swift recovery are disappointing. On the other hand, GDP growth in middle-income countries (MICs) has declined at a similar pace to that of HICs (although growth rates were higher in the former group) but has quickly rebounded. Even though MICs seem to have a growth engine of their own, the sustainability of growth in the medium term may still depend largely on the growth prospects of advanced countries. Analogously to MICs, growth in LAC was above trend in the run-up to the crisis. Afterwards, it experienced a sharp decline; however, a fast rebound to trend growth is expected during the recovery phase (See Figure I.B.3). When looking at the different components of aggregate demand, we find some distinctive features that characterize the current global downturn vis-à-vis previous episodes of severe crises (i.e., episodes in which a country was hit by more than one crisis type: banking, currency, external debt, or domestic debt crises). First, countries have emerged from the global

16 

downturn thanks in part to bold actions on the fiscal front. The ratio of government consumption to GDP moved from a below-trend average before the crisis to above trend at the onset. Although not reported here, there is no qualitative difference in the behavior of government consumption between HICs and MICs. They both have increased on average 1 percent of GDP in 2009 and are expected to remain at this new level for the next couple of years. Second, the decline in investment was not as sharp, especially in MICs, as in previous episodes of severe crisis (say, the collapse of investment in the East Asian tigers after the 1997–8 crisis). In the current cycle, investment fell on average less than 2 percentage points of GDP for both HICs and MICs whereas it dropped by more than 4 percentage points in MICS in past episodes. Lastly, this recovery has also been strengthened to some extent by a rebound in net exports that have risen to above trend levels after an initial collapse on the onset of the crisis. This pattern is somewhat unusual and weaker if compared to previous crises episodes, especially in MICs. The typical behavior of net exports is to simply increase as the crisis unfolded from slightly below trend to significantly above trend levels, pulling economies out of the crises. This time, however, we only observe a sharp decline from above trend levels and a mild recovery compared to previous severe episodes. In other words, the prospects of a sluggish growth in trade (and, especially, in imports from advanced countries) may hinder the likelihood of a stronger and faster recovery based on an external push.

The data for GDP and its demand components for 2010 and 2011 are forecasts from the Economist Intelligence Unit.

APPENDIX I.B  Characterizing the Global Recovery: How fast? What is driving it?

39

Office of Regional Chief Economist

Figures I.B.1–I.B.6 A.  I.B.1. Real GDP Growth: High-Income

Percentage Percentage Percentage PointsPoints Points

4% 3%

Severe Crises Episodes Severe Crises Episodes Current Crisis Current Crisis Current Crisis

T-2

T-1

T

T+1

T+2

T+3

T-2

T-1

T

T+1

T+2

T+3

T-1LAC Countries T T+1 T+2 Real GDP Growth Around Crises LAC Countries Real GDP GrowthCurrent Around Crises Crisis LAC Countries

T+3

Real LACCrises Countries RealGDP GDP Growth: Growth Around T-2

Severe Crises Episodes Severe Crises Episodes Severe Crises Episodes

T-2

T+1

T+2

T-1

T

T+1

T+2

Net Exports Around Crises T-2 T-1 % ofTGDP T+1 T+2 E.  I.B.5. Net Exports Net Exports Around Crises % of GDP Net Exports Around Crises % of GDP

3% 2% 1%

Current

T+3 T+3

1% 0% –1%

Severe Crises Episodes Severe Crises Episodes Severe Crises Episodes

T-3

T-2

T-1

T

T+1

T+2

T+3

T-3

T-2

T-1

T

T+1

T+2

T+3

D.  I.B.4. Government Consumption Government Consumption Around Crises T-3

Severe Crises Episodes

Severe Crises Episodes

0.4% 0.0% 0.2% 0.2% –0.2% 0.0% 0.0% –0.4% –0.2% –0.2% –0.6% –0.4%

Current Crisis

T-3

T-2

T-1

–0.6%

T

T+1

T+2

T+3

T-3

T-2

T-1

T

T+1

T+2

T+3

T-3

T-2

T-1

T

T+1

T+2

T+3

Current Crisis

T-2

T-1

T

T+1

T+2

T+3

T-1

T

T+1

T+2

T+3

Current Crisis

T-3 T-3

2% 1%

Severe Crises Episodes

T-2 T-1 % ofTGDP T+1 T+2 T+3 Government Consumption Around Crises % of GDP Government Consumption Around Crises Severe Crises Episodes % of GDP Severe Crises Episodes

0.6% 0.2% 0.4%

2%

Severe Crises Episodes

T-3

Current Crisis

0.8% 0.4% 0.6%

T+3

Current

2% 1% 0%

–2%

T

Current Crisis

–0.4% –0.6%

Current

–1% –2%

T-1

0.8%

Percentage Percentage Percentage PointsPoints Points

Current Crisis

T-2

4% 3% 2% 4% 1% 3% 4% 0% 2% 3% –1% 1% 2% –2% 0% 1% –3% –1% 0% –4% –2% –1% –5% –3% –2% –6% –4% –3% –7% –5% –4% –8% –6% –5% –9% –7% –6% –10% –8% –7% –9% –8% –10% –9% –10%

Real GDP Growth Around Crises Middle-Income Countries Real GDP Growth Around Crises Middle-Income Countries Real GDP Growth Around Current Crisis Crises Middle-Income Countries

0.6% 0.8%

Current Crisis

4% 3% 2%

0% –1% –2%

Percentage Percentage Percentage PointsPoints Points

Real GDP Growth Around Crises High-Income Countries Real GDP Growth Around Crises High-Income Countries Real GDP Growth Around Crises Severe Crises Episodes High-Income Countries

Percentage Percentage Percentage PointsPoints Points

Percentage Percentage Percentage PointsPoints Points

Percentage Percentage Percentage PointsPoints Points

4% 3% 2% 4% 1% 3% 4% 0% 2% 3% –1% 1% 2% –2% 0% 1% –3% –1% 0% –4% –2% –1% –5% –3% –2% –6% –4% –3% –7% –5% –4% –8% –6% –5% –9% –7% –6% –10% –8% –7% T-3 –9% –8% –10% –9% T-3 C.  I.B.3. –10% T-3 4% 3% 2% 4% 1% 3% 4% 0% 2% 3% –1% 1% 2% –2% 0% 1% –3% –1% 0% –4% –2% –1% –5% –3% –2% –6% –4% –3% –7% –5% –4% –8% –6% –5% –9% –7% –6% –10% –8% –7% –9% T-3 –8% –10% –9% T-3 –10% T-3 4%

B.  I.B.2. Real GDP Growth: Middle-Income

2% 1% 0%

T-2

Investment Around Crises T-2 T-1 % ofTGDP T+1 T+2 F.  I.B.6. Investment Investment Around Crises % of GDP Investment Around Crises % of GDP

1% 0% –1%

Current Crisis

0% –1% –2%

Current Crisis Current Crisis

–1% –2% –3% –2% –3% –4% –3% –4% –4%

T+3

Severe Crises Episodes

T-3

T-2

T-1 Crises TEpisodes T+1 Severe

T+2

T+3

T-3

T-2

Severe T-1 Crises TEpisodes T+1

T+2

T+3

T-3

T-2

T+2

T+3

T-1

T

T+1

Note: For the current crisis the T-period is 2008. The periods T+1, T+2 and T+3 are forecasts from EIU. Source: LCRCE Staff calculations using WDI and EIU data.

40

From Global Collapse to Recovery

Appendix II.A

Business Cycle Dating

Our goal is to compare the behavior of labor markets during the current economic recession relative to previous ones. Hence, we need to identify the cyclical turning points for each country. We follow the so-called BBQ algorithm for dating recessions, which was developed by Bry and Boschan (1971) and later extended by Harding and Pagan (2002) to accommodate quarterly series. The algorithm defines cycles by identifying troughs and peaks—any quarter lower/higher than the preceding and succeeding two quarters—and using various censoring rules about the minimum duration of the overall cycle as well as the phases of expansion and contraction. We define economic cycles based on movements in quarterly real GDP in Argentina, Brazil, Chile, Colombia and Mexico. Sample sizes, reported in Table II.A.1, vary across countries. Overall, we find 28 recessions. The duration of a recession (expansion) counts the number of quarters between a peak and trough (between a trough and peak). The average duration of a recession in the five countries studied is slightly above a year, at 5 quarters. Table II.A.2 below provides some summary statistics on the average severity of each recession in each country in our sample. We report the duration of its recession and its amplitude. The amplitude of a recession (expansion) measures the percentage change in GDP between a peak and trough (between trough and peak).

Table II.A.1  Dating Recessions in Selected LAC Countries Recessions   Country

Sample

Expansions

Nº of Quarters

Nº of Episodes

Nº of Quarters

Avg. Duration

Nº of Episodes

Nº of Quarters

Avg. Duration

Argentina

1990q1– 2009q3

79.00

5.00

37.00

7.40

4.00

42.00

10.50

Brazil

1991q1– 2009q3

75.00

7.00

25.00

3.57

6.00

50.00

8.33

Chile

1980q1– 2009q3

119.00

5.00

28.00

5.60

3.00

91.00

30.33

Colombia

1994q1– 2009q2

62.00

3.00

11.00

3.67

2.00

51.00

25.50

Mexico

1980q1– 2009q3

119.00

8.00

42.00

5.25

7.00

77.00

11.00

Source: LCRCE Staff Calculations

From Global Collapse to Recovery

41

Office of Regional Chief Economist

Table II.A.2  Dating Recessions in Latin America A.  Argentina

Period

B.  Brazil

Quarter Duration Amplitude Amplitude

Quarter Duration Amplitude Amplitude

Period

1992q2–1993q1

4

–6.7%

–1.7%

1991q3–1992q1

3

–11.2%

–3.7%

1994q2–1996q1

8

–8.1%

–1.0%

1993q3–1994q1

3

–7.5%

–2.5%

1998q2–2002q1

16

–28.0%

–1.8%

1994q4–1996q1

6

–8.0%

–1.3%

2008q2–2009q1

4

–9.9%

–2.5%

1997q3–1998q1

3

–8.7%

–2.9%

1999q3–2000q1

3

–2.8%

–0.9%

2001q2–2000q2

4

–3.7%

–0.9%

2008q3–2009q1

3

–9.2%

–3.1%

C.  Chile

Period

D.  Colombia

Quarter Duration Amplitude Amplitude

Quarter Duration Amplitude Amplitude

Period

1981q2–1982q4

7

–20.5%

–2.9%

1998q2–1999q2

5

–6.8%

–1.4%

1985q2–1986q3

6

–2.8%

–0.5%

2002q2–2002q4

3

–0.7%

–0.2%

1988q1–1988q3

3

–3.6%

–1.2%

2008q2–2008q4

3

–1.2%

–0.4%

1998q2–1999q3

6

–5.5%

–0.9%

2008q2–2009q2

5

–4.7%

–0.9% E.  Mexico

Period

Duration

Amplitude

Quarter Amplitude

1981q4–1984q3

12

–5.9%

–0.5%

1985q4–1986q3

4

–8.6%

–2.1%

1987q4–1988q3

4

–6.4%

–1.6%

1992q4–1993q3

4

–5.2%

–1.3%

1994q4–1995q3

4

–15.0%

–3.8%

1997q4–1998q3

4

–3.0%

–0.8%

2000q4–2001q3

4

–5.6%

–1.4%

2007q4–2009q1

6

–11.7%

–1.9%

Source: LCRCE Staff Calculations

42

From Global Collapse to Recovery

Appendix II.B

Labor Market Policy Responses to the Crisis17

This Appendix provides some examples of policies that were either introduced in Latin American labor markets or reinforced as a consequence of the international crisis. Its aim is not exhaustive, and the country coverage responds to the countries included in this note.

Argentina Argentina responded to the global crisis both reinforcing existing labor market policies and creating new ones. Labor market policies aimed at mitigating the effects of the international crisis can be grouped on three fronts: i) active labor market policies, ii) social protection and policies for unemployment protection, and iii) employment subsidies. Argentina introduced “Jóvenes con más y mejor trabajo,” a new active labor market program in June 2008, providing training and an opportunity to finish regular school to unemployed young workers (between 18 and 24) with unfinished primary or secondary school. It also reinforced an existing program, the “Seguro de capacitación y empleo,” which combines elements of non-contributory benefits for the unemployed with active labor market policies in the form of assistance in finding a job and training. While individuals were in principle eligible for the program for a maximum of 24 months, the government decided to extend eligibility beyond this limit up to December 31st 2009 in case the worker remained unemployed. Similarly, contributory unemployment benefits were extended. Regarding the protection of jobs, the “Programa de recuperación productiva” (REPRO) provides income support to firms in distress in exchange of a compromise not to cut employment. In principle, any firm engaged in a declining activity in the private sector is eligible to receive a monthly fixed-sum of AR$150 (US$ 38) for each of its employees up to a maximum period of six months. In exceptional circumstances, the benefit can be extended as well as the receiving period, up to no more than 12 months. Participating firms have to show the severity of the economic crisis hitting them, and provide plans to show their future viability. The program was extended as a consequence of the crisis up to December 31st 2009.

Brazil

Some parts of this appendix draw heavily on Freije-Rodríguez and Murrugarra (2009).

17 

Brazil articulated the response of its labor market policies to the international crisis on three fronts: strengthening contributory unemployment insurance, extending non-contributory income support

From Global Collapse to Recovery

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programs and raising minimum wages. Unemployment insurance in Brazil is quite limited. As a consequence of the international crisis, the government extended the eligibility of the “Seguro desemprego” for two additional months for the “most affected sectors and states.” The maximum period of eligibility became 7 months. Non-contributory benefits through the social assistance program “Bolsa familia” were also strengthened. The ceiling of eligibility was raised from R$120 (US$ 68) per capita to R$137 (US$ 77) per capita, which implies that some 1.3 million new families became eligible by the end of 2009. The third income support measure was to increase the minimum wage. In February 2009, the minimum wage was raised from R$415 (US$ 235) to R$465 (US$ 262), which has effects not only on low wage workers, since the minimum wage is used to define the benefits obtained through several social security and social assistance transfers.

is included in a package of reforms of the “Seguro de cesantía” that was launched before the start of the international crisis, but came into effect around May 2009 and included special provisions to cope with the crisis. Among the latter, an interesting supplementary measure is the program of “Protección al empleo y capacitación laboral,” which allows workers on a voluntary basis and as an alternative to a layoff to collect during up to 5 months benefits from the “Seguro de cesantía” while on training. The benefits are defined as 50 percent of the average wage of the worker during the previous 6 months. During the period the benefits are collected, the worker keeps his or her labor contract and all its related benefits (e.g. health insurance, pension contributions and different insurance policies). The measure was designed to be in effect between July 1st 2009 and July 1st 2010.

Colombia Chile We identify two set of reforms that tried to mitigate the impact of the international financial crisis on the Chilean labor market. The first falls within the broad umbrella of employment subsidies, while the second is related to the innovative program of unemployment benefits “Seguro de cesantía.” Within the employment subsidies, a new youth employment subsidy law was launched on January 2009. This program provides a 30 percent subsidy of the annual income for those individuals aged between 18 and 24, with finished secondary education and working in the formal sector, whose monthly (annual) incomes is below Ch$360,000 (approximately US$ 690). Within the same set of policies, and during the same month, a second law was passed that provides temporary income tax reductions for individuals and tax credits for firms that carry out training activities with their workers. The law provides special tax reductions to firms employing individuals who are beneficiaries of certain social programs such as “Subsidio familiar,” “Asignación familiar,” “Chile solidario” and “Asignación maternal.” The second set of policy reforms

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From Global Collapse to Recovery

Colombia articulated its labor market policy response to the crisis on two fronts: i) a series of tax cuts for small and medium size enterprises, in an effort to revitalize this sector and ii) enhancing a major training program, through the “Servicio nacional de aprendizaje” (SENA) to provide additional training to 250.000 young workers. Eligible individuals are between 14 and 26 years of age, unemployed, who live in conditions of severe or extreme poverty in rural and urban areas. SENA will provide to these young workers some 187 training programs. Up to 70 percent of the new training positions were posted during 2009. The program also includes some support to participants in the form in kind transfers (e.g. covering transportation). Firms interested in hiring trainees from the program may not have cut employment in the previous three months.

Mexico Mexico has in place several active and passive labor market policies. During the recent crisis, some of these policies were strengthened or expanded. On the

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side of active labor market policies, the “Programa de empleo temporal” (PET) which originally was operative only in marginal rural areas was extended to cover urban areas. The new program is called “Programa de empleo temporal ampliado” (PETA). In order to make this expansion operative, some 500 million pesos were added to the program, with a budget total in 2009 of 2,200 million pesos (approximately US$ 179 million). Also related to active policies, 1,250 additional million pesos (about US$ 100 million) were added to the budget for intermediation services controlled by the Labor secretary. Passive labor market policies were also enhanced. Individuals’ ability to withdraw funds from retirement accounts while unemployed was extended, and health insurance coverage of up to six months after dismissal for the unemployed worker and his or her family was granted. A new program, the “Programa para la preservación del empleo” was launched in January 2009 with the objective of maintaining employment in firms operating in tradable sectors in manufacturing that have been especially hit by the slowdown in global demand. The program, operating from February to September of the same year, was funded with 2,000 million Mexican pesos (US$ 162 million). Eligible firms who can prove they are under temporary distress might receive a subsidy of up to 5,100 pesos per worker (US$ 414) during this period. In exchange, firms commit to limit the layoffs

up to September in a maximum amount that equals a third of the fall in sales during the corresponding period.

Peru In 2009, the Peruvian Congress introduced temporary payroll tax holiday measures. Bonuses payable twice yearly and equivalent to two monthly wages have been exonerated from social and pension contributions until 2010. As a result, workers’ income will increase by 3.7 percent relative to pre-tax incomes, while firms will not have to pay social security contributions on these bonuses. The estimated fiscal cost of this measure of US$212 million is initially covered by the social security administration (EsSalud) and the public pension system (ONP), although these institutions are expected to seek compensation from the Central Government. The Peruvian Government also launched a publically financed retraining program, “Revalora Peru”, for workers who have lost their job since 2008. Training by the relevant technical education institutions is offered in the areas of construction, manufacturing, and tourism. Unemployed workers can register themselves in decentralized Labor Ministry offices to enroll in the program.

APPENDIX II.B  Labor Market Policy Responses to the Crisis

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From Global Collapse to Recovery

From Global Collapse to Recovery

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