Hello, welcome to visit Shanghai Forum
Thank you. I’m very honoured tobe here. Thank you to Fudan Development Institute. My theme is why did LatinAmerica fall behind East Asia? Indeed, just after the war, Latin America turnedindependent. For more than a century, since the beginning of the 19thcentury, Latin America was originally more developed than Asia. Asia then hadbeen a victim of European imperialism during the whole 19thcentury.Countries like China and India, for instance, experienced a strong dependencyon European and in the end also American imperialism, the classic model ofimperialism. But then there was the war and with the war, East Asia countries beganto turn independent and began to grow.
Now we have a problem. We have aproblem because the World Bank, and not only the World Bank but severaldistinguished economists, discovered the middle-income trap. What’s the middle-incometrap? Simply, the idea that when countries reach a certain level ofdevelopment, which is the middle-income level, they stop growing. They weregrowing fast but suddenly they began to grow very slowly. And this should bearound$1000 in ppp terms. Data seems to confirm this idea, but there are threeproblems, in my view, in relations to the middle-income trap.
First, the research made on thisthese subjects uses quite a large income interval to define what is middle-income.It’s not $10,000, it’s an interval. Second, the authors were unable to detectthe new historical fact that changed the search of developing nations. When weexplain some historical thing, for instance, the fact that countries suddenlybegan to grow slowly, I must find new historical facts that explain this fact.I cannot explain a new fact with old facts. And third,that’s very important,East Asia didn’t fall into this trap. So, this idea of middle-income trap isnot so general. A few words about these three problems. First, this large bandof income levels, here in Figure 1, I list four authors, or four groups ofauthors, and their respective papers and we see that the first, Michael Spence,this band of income interval is $5,000-$10,000.The other study is $2,000 to$7,500. Again, large bands and three or four authors. Here again, $1,000 to$12,000.So this story of the middle income trap is not so strong from the perspectiveof income level bands.
The second problem which wereoffered as causes to this problem, is inadequate institutions. This is very muchin the moment. Institutions matter, they say. For sure they matter, we don’t doanything in our lives since we were born than to follow institutions. But thereare no new institutions that explain why Latin America stopped and East Asiadidn’t. It’s sufficient indication, indeed, that the East Asians gave more attentionto education than the Latin Americans. But this is 1950 and not 1980. In the80s, look at Brazil for instance, especially in the middle of 1980s, begins anenormous effort to invest in education, to recover time in this area. Lack ofinnovation, again, is nonew historical fact. In supplementing investment in infrastructure,we always had problems, we didn’t stop investing but we investedinsufficiently. Demography etc, these are not new historical facts, these donotexplain why Latin America stopped and why East Asia didn’t. East Asiancountries continued to grow. South Korea and Singapore were middle-incomestates in the 90s but are today rich countries. China which had a much lowerincome per capita in 1990 continued growing quickly since 1980. Even thoughgrowth has slowed down, it remains high, very high. So definitely, the EastAsian countries didn’t fall in the trap.
Well, is there really a middle-incometrap? Or instead of speaking of a middle-income trap, I propose we speak abouta 1990s developing trap. And what is this? Countries stop growing fast andcatching up, not because they have reached a given income per person, or the middle-incometrap, but because one relevant historical new fact happened in the 80s. Andthis changes everything for Latin America.
What changed, US policy regimechanged. US policy regime changed. What I mean is this. In the 80s, we hadtrade and financial liberalisation. Over Latin America, we had the WashingtonConsensus, or the reforms or a kind of magical catchwords that changed thepolicy regime in developing countries, much more in Latin America than in EastAsia. It changed a lot also in East Asia in the 1990s, after the 1997 crisis.
But they changed much more inLatin America. In Latin America, we had a developmental policy regime and certainlyit’s these changes that happened in the 1980s in the US and in Europe, to aliberal policy regime. Such changes were defined by the US in 1985, by theBaker Plan. Baker was the name of the Secretary Treasury of President Reaganwho was then the US President. The idea was that countries should make reforms,privatise, deregulate, liberalise, and they should grow foreign savings, and ifthey did that, they would grow. Well, I suggest these reforms had the opposite result.Instead of promoting growth, in the case of Latin America, they hampered anddamaged growth.
First, a few numbers. Look at thegrowth rates of Latin America and East Asia between 1960 and 1980. East Asia isalready growing faster, but the difference was not big. And now, look whathappened after. See Figure 2, we could find out that since 1991, 1.2 vs 5.3, anenormous difference, definitely. This is the same thing in a graph according toFigure 3, the red line is East Asia, the blue line Latin America. It is very impressivehow different the stories of these regions were. Here, there are differences inthe countries for sure. See how enormous the increase was for China.
But why did the reforms have hadopposite consequences in Latin America? Instead of promoting growth, they madecountries stop and instead of industrialising as before, countries in LatinAmerica deindustrialised tremendously, especially Brazil and Argentina but notmuch Mexico, though they also stopped anyway. It was not because inequality increased,even though inequality is a big problem in Latin America. East Asia was in abetter situation in this matter, but this was not the cause.
Anyway, it was not the fact thatthe reforms were not accompanied by fiscal adjustments. Fiscal adjustments arevery important, but they do not explain it. What I propose is that, it wasbecause the reforms threw Latin American countries in the new developmental macroeconomictrap. What is the new developmental trap? The new developmental macroeconomictrap is the long-term increase in the interest rate above internationalinterest rate levels and mainly the long term over-valuation of the exchangerate.
After the 80s, or during the 80sand early 90s, interest rates increased very much in Latin America and exchangerate began to remain over-valued in the long term, in cycles. In cycles becauseyou have a crisis, a financial crisis, a big depreciation, then appreciation andthen stabilising in an over-valued bottom line for several years, and thenagain the country gets involved in current account deficits, increase inforeign debt and after that, in several years, a new financial crisis occurs becausethe currency loses confidence.
Two essential things caused thisovervaluation. Use and abuse of the interest rates and the dismantling of the intuitivemechanism of neutralising the Dutch Disease which was embodied in the country’strade system. Look, in 1989, I was invited to participate in a conference inJapan by the Institute of Developing Economies and the conference was acomparison of Latin America and East Asian at that time. And the super tide wasvery significant in saying, between countries rich in natural resources, andcountries poor in natural resources. And in that moment, inIn 1989, LatinAmerica had stopped while East Asia continued to grow. Why? At that time we didnot have the fundamental cause for this, which was the Dutch Disease, becausewe didn’t know what it was. It was at that time, more or less, that the firstmodel of the Dutch Disease was developed. I developed the second model a littlelater.
What is the Dutch Disease? I’mgoing to tell you more. To invest, a country must get the five macroeconomic pricesright. What are the five macroeconomic prices? Interest rates, exchange rates,wage rates, inflation rates, and profit rates. Interest rates, around which theCentral Bank makes its monetary policies, should be low while the exchange rateshould be competitive. That is, the competent tradeable non-commodity companiesof manufacturing industries should be made competitive with the best technologyavailable in the world. The wage rate should grow with productivity, not morethan that, so the profit rate is satisfying for big enterprises including andespecially manufacturing enterprises. This is what this theory says.
This theory also says that growthdepends on investment and investment depends on the exchange rates. This is notin the textbooks. In no book or textbook of developmental economics there is achapter in exchange rate. Why? Because this theory does not suppose that theexchange rate may remain overvalued for several years. But once you drop thisassumption that the exchange rate is just volatile, but accept that the exchangerate is not just volatile, it is volatile with a tendency to be overvalued inthe long term, then when the businessman makes his business decisions, he takesinto consideration the overvaluation of the currency and does not invest.Because the company that utilises the best technology is not competitive.
Well, why did interest rates becomeso high in Latin America? First, to attract capitals. In Latin America, theyaccepted the idea that the best way to grow is to use foreign capitals. This isa big mistake. Second, they used interest rates to control inflation. There is noreason why you need high interest rates to control inflation. When inflationgoes up, you need a little more interest rate but not 5, 6, 7% in real terms.And third, because interest rates are very good for venture capitalists, youhave to remember that capitalists are not only businessmen, entrepreneurs.Today, in all countries, the venture capitalists that live on interests,dividends, real estate rents are very important and they like very much highinterest rates and when they are powerful in the government, this also helps toexplain why interest rates are high. For sure, interest rates discourage investments,appreciate national currency, and enrich unnecessarily the venture capitalists.So, this is one cost of the over-valuation of interest rates.
The second is the Dutch Disease.What is this thing that you don’t have in East Asia but Latin America has? The DutchDisease is the long-term overvaluation of the exchange rate of a country thatexports commodities. To export these commodities at a profit, these countriesrequire an exchange rate substantially more appreciated than the exchange ratemanufacturing industries in countries that utilise state-of-the-art technologyrequire to be competitive. This is the Dutch Disease. So, this is a veryserious Problem.
A country does not industrialiseif it has the Dutch Disease. Or in the case of Brazil, Brazil between 1930and1990, Brazil grew very fast, especially between1930 and 1980 because itneutralised the Dutch Disease. Not only Brazil, several other countries also didthat. They neutralised intuitively, which basically meant the imposition ofvery high import tariffs, so would tell you is that import tariffs are notalways protectionist. Import tariffs are not protectionist in the beginning ofindustrialisation, by the argument of infant industries. But for countrieswhose industries are not ‘infants’ any more but has the Dutch Disease and areneutralising the Dutch Disease with import taxes, import tariffs where theneutralisation of the Dutch Disease is only in relation to the domestic marketand not to enable its companies to export but to enable them to compete withforeign firms in the domestic market, we cannot say that this is protectionist.It is just a way of neutralising Dutch Disease and assuring equal conditions ofcompetition to the companies. Well, this was what happened in Latin America orin Brazil particularly between 1930 and 1980.
However, in the 1980s, this wasstopped. Why? Because you open the economy. When you open the economy, thesystem that neutralised the Dutch Disease was dismantled. When this happened in1990,the manufacturing industry began to have a competitive disadvantage of around20%. This is disastrous. The consequence is that the economy, the manufacturingindustry, entered a big crisis and we have a major deindustrialisation of theeconomy. This happened practically in all Latin American countries indifferentproportions but it didn’t happen in East Asia, for sure. This happened becauseof the reforms and the interest rates. Why did the interest rates increase somuch? Because there was financial liberalization and as the liberal economiesused to say, Latin Americain the 70s and East Asia were in financialrepression, because interest rates were very low. So to depress the finances,you have to increase the interest rate, which led to a very high interest rateand very appreciated currency. This was the developmental trap of the 80s.
In synthesis, when the exchangerate is not managed as it is done in the East Asian countries, certainly in China,the country engages in current account deficits, grow in foreign savings. T,that is very bad. It falls into a financial crisis. The Dutch Disease, ifexisting, pulls the exchange rate up to the current equilibrium and the highinterests rate pulls the exchange down to the current account deficit. Lowgrowth, deindustrialization and falling behind thus is inevitable.
My time is finished. I think mybest message is given, these ideas I made a very big summary, developingseveral papers and three books. They are possible also in English, these ideasare called New Developmentalism, and I hope that this helps us understand morewhat’s happening in our two continents. Thank you very much!
(This article is edited based on the recording and has notbeen reviewed by the speaker.)
