American Enterprise Institute

May 29, 2008

[Edited transcript from audio tapes]

8:45 a.m.	Registration
9:00	Special Remarks:	Anoop Singh, International Monetary Fund
9:30	Discussants:	Desmond Lachman, AEI
		Nancy Lee, Center for Global Development
		Roger F. Noriega, AEI
	Moderator:	Megan Davy, AEI
10:45	Adjournment

Proceedings:

Anoop Singh:  --is a downturn in the United States, as we all know well, and where growth this year on average is likely to fall to a low but still positive level.  The main point I want to make about the U.S. outlook as a context to Latin America, is that for a number of reasons, which I won’t go into any detail at this point, a number of reasons the recovery in the U.S. is likely to be gradual, to be prolonged. 

And why do I say that?  And that is because of the nature of the shock that has hit the United States, which at its core is an initial decline in house prices that really is unprecedented in the post-war era.  And this has hit the financial system that was probably at the peak of its financial leverage.  And why this is important is that our sense is that this interaction between the macro and the financial side--the housing and the financial side--is unleashing pressures that will produce negative feedback loops, and it will take time for those balance sheet adjustments to play out. 

It is likely that consumption will be more effective this time around because of these feedback loops.  And this is certainly consistent with the international experience when we have housing corrections.  It’s also consistent with what we have had in the past in the U.S. regional slowdowns.  And if you look simply at the international experience in dealing with housing busts, you will get very depressed because you will find that those are really drawn out recoveries.  However, this is important also for Latin America, therefore crucially, is that we don’t believe that the recovery in the United States is going to be as drawn out, as protracted as will be suggested by the experience of other advanced economies that have had housing corrections.  But having said that, neither do we believe it’s going to be V-shaped, as the U.S. recoveries generally are.

 So to cut to the chase, we think that recovery in the U.S., while not as slow and protracted as other international experiences, will be somewhere between the normal typical V-shape we’ve gotten used to expect in the U.S. and U-shaped that we’ve seen in international experience.  And I say that because, in many ways, the U.S. economy is more flexible than other advanced economies.  The policymakers here have reacted as you’ve seen--very fast to events with strong innovative actions.  U.S. corporations continue to have strong balance sheets and, of course, we have in the U.S. exceptionally flexible labor markets.

 And, finally, as we’ve seen in the last two months, U.S. banks have shown really a remarkable ability to face up to their losses and proactively raise capital.  We’ve seen this in some of the financial indicators that they have pulled back from the stresses of two months ago, although, [indiscernible]. 

But the second important shock that is now hitting us is from global food and oil prices, [indiscernible] prices.  And the problem here, both for the U.S. economy and for Latin America, is that some of the negative feedback effects that we are seeing between the housing and the financial sector size in the U.S. risk being accentuated, supplemented, by what I call a price shock.  This price shock, both here and elsewhere, will depress consumer spending and agri-demand, raising inflationary pressures that will make it more difficult to manage the recovery.  It constrains policy choices.

Now against this, we do see that growth in the rest of the world is holding up fairly well, especially in China and India, although there is some moderation from their recent highs.  So, in short, what is the context for Latin America?  We have, in the U.S., probably a prolonged recovery, not as quick as the past.  We have an inflation shock that is going to complicate recovery here and overseas.  But, finally, we have the rest of the world holding up fairly well.  This is the broad context for Latin America. 

Now let’s go on and see what this means for Latin America.  On the financial channel, the news is fairly good.  We haven’t seen in Latin America any direct linkages or exposure to the kind of securitized products that have been at the heart, the eye of the storm in the U.S.  We’ve not seen that.  We also see that the region is now much better protected by its physical and external positions than, perhaps, we have seen in a generation in Latin America.  We see the sovereign financing needs have declined, and that’s good news.  There is some risk for the corporate sector, but I think so far they’ve been manageable.  So, briefly, the financial linkages we see as much less as in the past.

Let’s now look at real linkages.  And here our research shows, as you look at the evidence of the last ten years, Latin America has grown less directly dependent on U.S. demand.  And linkages with Asia have increased over the past decade.  China, in particular, through its impact on commodity prices has become a very important factor, including as an export destination in its own right.  And we’ve seen that growth is holding out relatively well in that part of the world.  So, so far, we find that the real link from the U.S. economy from the global outlook to Latin America may not be that serious.

Let me quickly add that this is not completely untarnished news.  There are some concerns.  And that is because much of Latin America’s recent export growth does reflect the commodity boom of prices rather than volumes.  And the flip side is if you go back the last ten, fifteen years and look at trends in manufacturing, the share of manufacturing and output, we find that this has been crowded out in most countries in the region.  And the region has actually become more dependent than in the past on this volatile mix of hydrocarbon, mineral and grains prices. 

But, nevertheless, for now the immediate growth outlook for the region may not be that affected by some of the events taking place in the north.  So then, what are the challenges?  My sense is that the immediate challenge facing the region is inflation.  And, of course, Latin America, as we’ve seen, is not alone in this key respect.  These price shocks--from energy, from food that we see and experience every day--they have been a key channel driving prices higher in other emerging market economies. 

And we see that the effects have been especially marked in economies where extreme rates have been less flexible.  But in many of these economies, including in Latin America, high domestic demand has been a major factor.  This has come from the boost in incomes resulting from the terms of trade, which is the other side of the commodity boom, and also because of the impetus from Capitol Hill.  So we see in Latin America, inflation rates have reached double digits, levels in a number of countries certainly rising above the comfort zone for many of the regions and for banks. 

However, it is good news that at least some of the banks, some of the countries in Latin America, are reacting preemptively trying to stay ahead of the curve.  Brazil, for example, we’ve seen that the central bank there has acted preemptively to force [indiscernible] and we see that inflation expectations, therefore, in Brazil remain relatively well-anchored.  Mexico too, we find that policy rates remain positive in real terms.  And monetary policy is, we believe, well directed at inflation coming back to the target range.

But there are still many challenges.  The first challenge, which I’ll digress for a moment, is the impact on the poor.  Here, I’ll be brief.  I’ve written about this in other forums.  You can probably see that.  Our sense is that Latin America, perhaps uniquely among other emerging market regions, has developed social safety net programs in certain countries that have been highly cost-effective, like in Brazil, and Mexico, and Chile.  And these can be adapted and extended quite quickly at relatively low cost to address some of the impact from the poor of the price shocks.

Let’s go back then to the inflation challenge.  And here we must look very closely because, as I said, one lesson from the historical experience is that domestic policies have tended to amplify the external shocks.  And so we see a concern that in many countries in the region, macroeconomic developments have been pro-cyclical.  That means that they have been adding to demand instead of moderating it. 

We see that credit growth has been very rapid in the region--in some countries in the range of twenty-five to thirty-five percent.  Some of this increase, of course, is overdue.  The region has for long lagged in intermediation.  So it may be that this is just a catch-up, but history also tells us that when you have these kinds of credit booms, standards deteriorate.  We’ve seen that right here in the U.S.

The second concern is on fiscal spending.  Although the region has had primarily surpluses that, as I said, are protecting the region, we’ve seen that spending has grown very rapidly and has become dependent on a kind of permanence in commodity price revenues that may not be there.  And so there is a need, both in credit, in monetary policy and in fiscal policy to be more conservative, to ensure that essential needs are met and that policy does not amplify these demand shocks and price shocks that we see around the region.

So that’s really all I wanted to say.  I will end with a final thought, and that is, I’ve spoken of inflation as the core near-term challenge.  And it is a core near-term challenge because Latin America over the last ten years has done more than it has done in a hundred years in bringing inflation down.  We see in the region much more consensus, politically, to low inflation, to macro-stability and so it is all the more important at this time when there is the first major test of the regions’ more autonomous central banks that they meet that test and keep inflation down. 

But, equally, there is an enduring long-term challenge and that long-term challenge is that Latin America has had a productivity gap and investment gap with other emerging markets.  And that needs to change.  We see, as you develop projects and scenarios, of where we would like Latin America to be, say, twenty-five years from now, thirty years from now, and you set any kind of sensible objective, let’s say doubling per capita income in three decades.  That is not a very ambitious objective given what Asia has done. 

You find at the micro level you will have to make great strides--not just raising investments because it’s not just quality that matters, it’s the efficiency--and so there is an investment flag and there is a productivity gap.  And it is critical that that be met.  In the long run, it is only rapidly growing real incomes on the sustainable basis that can generate the consensus also to keep macro-stability.

So that’s what I wanted to say this morning and I thank you for that opportunity.

Roger F. Noriega:  Thank you very much, Dr. Singh, for that very insightful summary.  We invite questions from the audience.  Dr. Singh will call out the questioners.

Anoop Singh:  Yes.

Roger Noriega:  And there’s a microphone coming to you.  Please identify yourself and your organization.

Cesar Munoz:  Cesar Munoz with EFE News Service.  I have a question--a two part question--on inflation.  It seems to me that some of the authorities in the region say difficulties reacting to these price shocks because they see them as external price shocks.  How will an increase in interest rates affect that?  There is the dilemma.  How can they, you know, internally affect those prices without--and there is the danger there is putting a stop to their economic growth?  So what kind of measures do they, policies, do they follow [sounds like]?  And also, you mentioned countries that have acted preemptively.  What countries have not?  What are your concerns in Latin America?  Thank you.

Anoop Singh:  All right, well, those are two very good questions, the second one, in particular.  For the first, it is a policy dilemma because much of these are external shocks.  The concern is is that these shocks are not temporary.  Clearly, some of the increases we’ve seen in recent days or weeks may be reversed, but our projections, as of those of others, show that much of the increase of the last one year will probably be a more medium-term phenomenon that many of us had thought even six months ago. 

So we are, probably, looking at fundamentals driving the bulk of the recent price increases, and therefore, what should policymakers do?  Well, the first is that the region, and other countries too, have central banks that are now more autonomous and many of them have inflation targeting frameworks.  And, therefore, in the end, they need to follow as they are doing--those inflation targeting frameworks.  Those inflation targeting frameworks have developed over the last five to ten years.  They do specify a timeframe, in some cases, for inflation to come back to a target then.  It doesn’t have to be tomorrow or next month. 

And so, in the end, I see the central banks in the region generally not adjusting those frameworks, but keeping to them, and that’s important.  And in terms of policies, our concern is that these shocks do not translate into, say, wage contracts.  And, therefore, the most important indicators to look at is how are wages responding because if wages respond in a negative way, you’re going to see these shocks getting entrenched.  So we are dealing with more permanent price shocks than we would have hoped six months ago. 

The region does generally have inflation targeting framework or other such mechanisms.  They are following them and, in particular, we need to look at the impact on wages and wage responses.  Now I would say this--you asked me which countries or which banks are doing better--I’m not going to give you a scorecard. 

What I am going to say is something that I’ve been saying for the last two or three years.  I am completely impressed by the greater consensus politically.  We all know the central banks want low inflation, so it is not a very big development to see the central bank of country X want to bring inflation up.  What I have been impressed by is politically there is no country, including the ones that may be on your mind, that are wanting high inflation.  Every country wants to bring inflation down.  We may not agree with every policy response of some of the countries because there is a variety of circumstances, but the point is nobody is advocating keeping inflation high. 

Nobody is advocating inflating [sounds like] financing from the budget or from the central bank.  And so there is a broader commitment to bring inflation down, and I do believe, therefore, the region is better placed than it has ever been to deal with these shocks.  There are great difficulties, but they are better placed.

Harvey Bronstein:  Good morning.  I’m Harvey Bronstein at the Small Business Administration.  You’ve mentioned the issue of shocks, and generally when we talk about shocks we talk about negative shocks, but I think in the case of Latin America, for some countries it’s actually been positive shocks, including improvements in terms of trade of many countries.  Latin America is also by design or by accident managed to delink itself from a lot of the economic problems in the United States.  It’s effectively delinked itself from the relatively slow growing U.S. and linked itself to the relatively high growing Asia. 

In your view, how does this balance out in terms of the negative shocks for some--certainly if you’re a poor person buying food, it’s a negative shock to have the price of food go up--but how do you balance that out with the positive shocks mostly due to the commodities boom?

Anoop Singh:  Well, I think that’s the key issue.  It’s playing out differently in different countries.  Obviously, you have Central America and the Caribbean at one end.  They had not had, in terms of trade, improvement.  They’ve had just a shock.  The rest of the region--the big economies in the south--have had, as you said, the terms of trade improvement and now the price shock.  The point is, that from a financial strength, fiscal strength point of view, partly because of those terms of trade improvements then the trade gains, the countries are much better placed. 

And so I would say that they have the ability to deal with the poverty impact.  It is crucially important that poverty--the decline of poverty that is seen in the region the last eight to nine years, ten years--not be reversed.  And our sense is, as you look at these conditional cash transfer schemes, you see the highly successful program in Brazil.  That now reaches ten or eleven million families.  It costs just a half a percent of GDP. 

So our sense is that in the region, in many countries, there are ways in which to protect the poor from the price shock.  And to my mind, that should make it easier to deal with the macroeconomics and not to give in to inflation pressure.  It is only too easy to say this is an unprecedented shock and, therefore, let’s adjust the inflation framework.  Let’s raise the inflation target.  Let’s have a longer timeframe for being--I do believe it will be a mistake in the face of the current test to do anything that will suggest that the region’s newfound commitment to low inflation is going to weaken this time.  And I’m helped in that advocacy by the sense that the impact on poverty can be alleviated.  That’s very important.

Well, let’s go over there first.  Yes?

Adriana Garcia:  Hi, I’m Adriana Garcia, Reuters Latin America.  I would like to know what would be the suggestions for countries that don’t have such programs as those well-structured in Mexico and Brazil?  What mechanisms can they use to deal with high prices of food and energy?  And, also, if you have revised any estimations for the region for inflation and growth?

Anoop Singh:  Well, let’s take the case of Haiti.  Haiti may not have the sophisticated cash transfer schemes that we’ve seen in a growing number of countries, but, still, Haiti has shown in the last two months that it has the ability to try to deal with the shock.  And in the case of Haiti, they have announced a temporary subsidy on food prices, which is being financed, we hope, by greater donor contributions from abroad. 

So at one end of the spectrum where this is a high vulnerability of the poor and there isn’t the time or the capacity to quickly build up these cash transfer schemes, I think countries will either have the fiscal strength or will have access to international resources that will allow them to have targeted subsidies on certain products so that in that period, other schemes can be developed.  Now, at the other end of the spectrum, you’ve got the countries like Mexico and Chile and Brazil and so on that have these schemes, but in the middle of the spectrum, you have countries like Peru that has not had, for long, this kind of conditional cash transfer scheme, but they have been developing it over the last year and doing it rather well.  So it is not as complicated at we may believe to develop it. 

So either through targeted subsidies or through cash transfer schemes, there is a spectrum of responses, and what we are doing with our partners in the World Bank and others is trying to see country by country, what is the appropriate response?  And we do believe that each country does have access to fiscal resources or international resources that will allow a response on its impact on the poor without--this is very important--without resorting to inflationary finance from the central bank for these kinds of schemes. 

For Haiti, that is crucial--that they need to respond to the poverty impact, but not by inflationary financing.  After all, if you were to estimate the poverty impact of a small increase in the inflation rate over what it would have been, you will find that the impact of the small increase on poverty is going to overwhelm any gain you may get from using your resources for poverty.  It’s very important we keep separate schemes to alleviate the impact on the poor from the macroeconomic policies that will keep inflation down because there is no scourge worse, as you all know in this room, than inflation in these economies. 

We’ve seen what the boom and bust cycles have done in Latin America for a hundred years.  And that effect has not so much been on economic growth, but on the impact on the poor and inequalities.  So I think it’s very important at this time of global shock to keep the two things separate--they are connected, but separate--policies to address the impact on the poor from the macroeconomic.  These should not be integrated too much.

Bill Belmont:  Thank you.  Bill Bell, Mistsui, Inc..  The IDB is supporting an expansion of biofuels production throughout the region.  Can you comment about the future role of biofuels in Latin America?

Anoop Singh:  Well, I’m not an expert myself in the biofuels.  I don’t think I could add to the debate myself, but I do know and I do imagine that in this period of the global shock, this is a right moment to look and debate on all the factors involved.  And all the factors involved producing the global shock in oil and food must include demand, supply, environmental policies, and bio-fuels.  So there is a need for a debate.  My sense of that debate needs to be integrated across the dimensions involved, and I’m sure what the IDB is doing on bio-fuels will be a very important factor in a debate that needs, however, to be broader and integrated.

Roger Noriega:  Well, thank you Dr. Singh for the terrific and thought-provoking presentation and your insights on what’s happening in Latin America today.  We also thank you for your good work in pushing sustained economic growth with sound policies.  Thank you very much.  [Clapping]  You’re certainly welcome to stay for this panel.

Anoop Singh:  I’ll stay for a bit.

Roger Noriega:  Okay, great.  This next panel is going to be moderated by Megan Davy who’s the principal author and inspired the paper that AEI just published yesterday on the impact of the U.S. economic downturn in Latin America.  Megan.

Megan Davy:  Great.  Thank you and good morning.  I want to thank you all for joining us bright and early this morning.  I want to welcome our speakers and especially thank Doctor Singh for his introductory remarks.  The title of this morning’s event is “What If the United States Sneezed and Latin America Didn’t Catch a Cold?”  I think this is a question that might have seemed much more like wishful thinking than a reality during previous crises, even as recently as the Asian financial crisis in the late nineties.  So it’s with some surprise that I say, in fact, that we’re quite serious about the title of this event.  As Dr. Singh suggested in his remarks, it seems that Latin America will mostly not catch a cold, and certainly won’t see impacts to the degree that it might have in previous episodes. 

We’ll discuss the details a bit more, but initial indicators suggest that Latin American economies will remain fairly stable, at least as it concerns spill-over effects from financial turmoil in the United States.  Latin American financial market indicators have faired much better than those in the United States, I think, which we’re all a little surprised to see. 

And while it does appear that the growth will slow a bit in the region, we really don’t predict the slowdowns that we are seeing currently in U.S. GDP growth.  And I’ll let the economists talk about whether or not we can still talk about recession in future months.  I’m sure Desmond will have plenty to say about that.  But I do think it’s worth noting that Latin American governments deserve a lot of credit for enacting much needed reforms to strengthen their financial institutions.  And this will really go a long way in allowing countries to weather the storm.  But the job is far from over, and there are some important challenges that lie ahead.  I think, again, that the title of Desmond’s presentation will suggest that also.

I do want to mention a few of these challenges briefly.  First, the global economic turmoil will affect countries in the region differently, and some countries, I think, will struggle more than others in keeping their economies stable.  By this I mean that sort of irrespective if their current policy environments, some are better poised thanks to high commodity prices and their own exports to weather the storm better than others.  I think countries such as Mexico and the Central American countries will find it, that aren’t exporting those commodities, will find it a lot more difficult to deal with global slowdown, especially as they’re much more linked with the U.S. economy. 

Second, for some countries domestic policy environments will matter.  I’ll leave it to our panelists to name specific names, but I do think there are some countries who have poorly managed their economies in recent years.  And I think some would argue that they have squandered the opportunity that positive global conditions have provided them.  The global economic slowdown may stress their economies and really bring them close to a boiling point, politically, if not economically. 

And, finally, rising--and, again, this was mentioned a little bit already--but rising global and commodity and food prices may keep some countries afloat despite the global economic slowdown.  But this phenomenon will introduce inflationary and political pressures that Latin American governments have not had to address recently.  By this I mean not only will rising prices make it more difficult to meet inflation targets--and we’ve already seen countries such as Peru, Chile and Uruguay that are struggling and actually have not been able to meet their inflationary targets recently, although it seems they’re doing a little bit better--but countries will also have to respond to the effects that rising food and commodity prices will have on the poor and middle classes.  And this is something that they haven’t had to do recently, and some have really struggled with this.  And whether and how they address these new challenges will have serious repercussions for the future of their people. 

With that I’d like to turn to our panel to address some of these issues.  We’re going to start with Desmond Lachman and move this way, if that’s all right with everyone.  You all have their bios in your packets, but I will briefly introduce our panelists.  Desmond Lachman joined AEI as a resident fellow after serving as managing director and chief emerging market economic strategist at Salomon Smith Barney.  He was previously deputy director in the IMF’s Policy and Review Department and was active in staff formulation of IMF policy towards emerging markets in general and Latin America in particular.  Desmond researches topics like the U.S. housing market bubble, the dollar crisis, challenges to the Federal Reserve, and IMF and World Bank reform.  I’ll let you go ahead and get started.

Desmond Lachman:  Thank you very much for that introduction, Megan, and thank you, Roger, for organizing this.  I’m wanting to present a PowerPoint presentation that will elaborate on a few of the points that Anoop Singh has raised, but just to preface those remarks, I’d say that there’s much that Anoop Singh has said with which I would certainly want to agree.  I think that I agree with him that inflation is certainly a challenge in the region, that there has to be concern about some of the credit developments, there’s got to be concern about some of the items on the public finance. 

Where I would take a different view from Anoop is in terms of what is the outlook, how are the shocks really going to play out?  And I take a very much more pessimistic view as to where we’re headed.  I also want to differentiate between the performance of some of the countries that Megan has raised.  I think there is a divide.  I think that one doesn’t want to paint Latin America with the same brush, that they’re countries that have followed very good policies, they are likely to be rewarded for that and I put into that category places like Brazil, Mexico and so on. 

But the countries in the region of Argentina, Venezuela that, in my view, are trodding well trodden paths that lead to disaster when the commodity bubble bursts.  So now to put a fine point on it, I think that some parts of the region--Argentina, Venezuela, Bolivia, etc.--already are going to be very exposed once this quantity price boom turns down.

Let me just start with the good news--just saying that this time around Latin America already has performed rather well.  I didn’t think that I would see it in my lifetime that Latin America would be regarded as the safe haven in terms of a global economic storm, but that is certainly what we’re seeing. 

And this chart is just showing two lines--the one is U.S. high yield, which is the red line, and you’re just seeing how spreads, the interest rate having to be paid, increased by something like six percentage points for corporations in the United States with bad credit during the crisis.  Whereas Latin America, the blue line, you barely see that moving.  And that, I think, is very much in contrast to what occurred in 2000 when spreads blew out completely.  This is just one indication. 

If you’re looking at Latin American stock markets, you’ll find that they’re very buoyant, that there are other indications that the markets currently local currency investment, currency’s performance, markets really very much favor Latin America.  Part of the reason I’d suggest is that there’s been a substantial improvement.  If we talk about the region in general, there’s been a substantial improvement in the fundamentals of the countries.  Particularly what you see is the difference these bars are showing the deficits on the external performance of Latin America, and we’re now moving from 2000 onwards. 

Latin America has been running surpluses.  If you look at the next chart, which is showing both the public finances, the black lines, are just showing the deficits narrowing.  Latin America certainly has improved in terms of its fiscal performance and what we’re finding is that debt levels are going down substantially.  So Latin America this time around is in a very much better position to face the external shock than it was before. 

My question, though, is that we’ve really just had a first round of the shock and, I think, that if we now get a second leg of the shock later on, what we’ve got to expect is Latin America could be affected by the fact that its global markets are likely to contract, but also what we could get is we could get risk aversion coming back into the markets.  Latin America would have to borrow very much and there’s very likelihood that quantity prices aren’t going to be as good as they were before. 

Now the reason that I’m saying this is that I think right now the U.S. is being subjected to three major shocks, and I don’t see that the shocks are in any way attenuating.  In fact, I’d go as far as to say that what we’re getting is we’re getting intensification of those shocks.  And the other point I’d make is that any one of those shocks, in the past, would have been sufficient to tip the United States into recession.  I’m not sure that I understand the argument on the other side – that if you’ve got three of these shocks operating simultaneously, why the United States is going to scourge a recession.  What is occurring right now is the tax rebate is just delaying this, but the issue is what happens in the fourth quarter when those rebates have faded.

Let me just turn to the three shocks and just show you a bunch of charts that indicate it.  The blue line here is the rate of price increase in the United States adjusted for inflation.  What you see is up until about 2006, we were increasing house prices in the United States at, adjusted for inflation by ten percent.  Now what’s occurring is house prices are declining by something like fifteen percent, and as Anoop Singh indicated, this is unprecedented in the United States.  What is of concern is that house prices are now declining at an accelerating rate, that the numbers are coming out showing that far from stabilizing, these markets look like they’re getting worse. 

This chart just indicates how high the house prices in real terms, adjusted for inflation, got during the run-up.  It’s giving some sort of sense as to how far prices can decline.  So the red line is, more or less, a trend line.  But if we adjusted it for looking at house prices in relation to income or relation to rents, we’d get very much the same story, that we’ve got to something like forty percent above what the trend line is.  So on that metric, one would expect house prices in the United States to decline by something like twenty percent going forward. 

My concern right now is this chart is indicating that there are a million overhanging the United States economy.  Right now there’s a glut of houses, and what’s occurring is the banks aren’t lending so we’ve got a glut of houses on the market.  We’ve got banks not lending.  And then the really scary part, in my view, is the foreclosures that are occurring, that we’ve had foreclosure procedures initiated since the, in the second half of 2007 running at something like one point eight million units. 

So it’s very difficult to escape the conclusion that house prices in the United States are going to continue to fall.  That’s going to have a very big impact on wealth in the United States.  It’s going to have an impact on consumers’ ability to borrow.  This is really a major league shock going forward.

As I said, it’s occurring with another shock, and this chart is just indicating banks’ willingness to lend.  But banks have got, the financial system is now estimated to have something like one trillion dollars of losses, and certainly, I’d agree with Mr. Singh that the banks have made efforts to improve their capital raising.  But there is something like a hundred billion dollars short of capital going forward, and this chart is indicating that banks aren’t in the mood to lend.  So if banks are restricting credit, and this process will continue--that these processes don’t finish overnight, these are long drawn-out processes for banks to repair balance sheets --we’re going to have restriction on the credit side.

The third shock, which is the oil price shock, and I think that this chart is worth just pondering about.  This is a long run chart.  It goes back a hundred years.  I won’t really consider what happened before, but I’ll just look from the nineteen seventies onwards.  These are adjusted for inflation, and what strikes me about the chart is that oil prices now are at one hundred thirty dollars a barrel.  The run-up from sixty-five dollars a barrel to one thirty dollars a barrel has to remind one of the 1979 oil price shock.  And the 1979 oil price shock created really great problems for the United States.  I should say the global economy, as well.  Now we could argue that we use less energy than before, but that doesn’t get away from the fact that this is a major league shock.

So I would think that going forward, what we’re going to see is we’re going to see renewed pressure in financial markets coming out, certainly, before the end of the year.  So Latin America, the fact that it’s done well in the first round, I don’t think that this is a reason for complacency, that they really have to focus on policies that will keep them well-protected going to the next round.

Let me just mention a few issues just in terms of exposure.  I just put up this chart here, which just drives home the point that commodity exports are really very important for a number of major Latin American countries.  If you look at Argentina, Peru, Ecuador, Chile, Bolivia, Venezuela, all of those countries, the exports, commodity exports are something like ten percent of GDP, if not more. 

So what occurs on the commodities side is pretty critical.  I don’t buy the view that the United States can have a major slowdown.  In fact, I think that we’re going to have a recession that is worse than the average post-war recession.  I don’t see how we’re going to get decoupling--the rest of the world going in one direction and the United States going in another--not simply because the United States is still a dominant player in the global economy, but more because the shocks that are driving the United States into recession are being shared by other regions. 

Europe and Japan are also paying high prices for oil, they’re also subject to the credit crunch, they’re also having to deal with a depreciated dollar.  So we’re already going to be seeing that spreading.  And I’ll tell you the same thing with China--that I just don’t see how China can expect to increase exports by thirty percent a year, which is what’s driving its growth--if the United State and Europe go into a recession.  So I think that that’s got a really important bearing on where commodity prices might be going.

This chart is just indicating the commodity boom, which is very spectacular--not simply effecting oil, but effecting other commodity prices.  One point that I’d like to just mention on the commodities side is that there’s a fair amount of, you might want to call it speculation or you might want to call it investing in different asset classes, what we’ve got is a fashion.  It wouldn’t be the first time that a fashion occurs that people think that commodities, the world is running out of commodities. 

We’re going to be booming the whole time.  You’ve already got to allocate more capital to commodities.  So what we’re getting is we’re getting pension funds, insurance companies, hedge funds, you name it, all sorts of institutions buying future contracts which are putting pressure on commodities, and this chart is just showing that the amount of open positions on the futures market are now something like two hundred and sixty billion dollars.  And the calculation that people have made is this is equivalent to something like nine hundred million barrels of oil, which is the increase that China does in a year.  So this is a very significant factor that could be reversing.  I would not want to rule out the fact that as the U.S. slows, we’re going to get commodity prices coming down from these heady levels and that will expose the region.

Let me just conclude by just saying, again, that I think that the countries who are following correct kind of policies are likely to benefit more than those that are following poor policies.  There’d also be the point that I’d make is that some countries in Latin America are very much more exposed to the United States than others.  And what I’m thinking of is a place like Mexico--eighty-five percent of Mexico’s exports go to the United States. 

If the United States goes into a severe recession, that’s problematic.  And what I would suggest is that the first phase of the United States’ recession or slowdown, if you will, was mainly concentrated on housing construction, which isn’t something that really impacts exports, so the linkages, if this now spills into U.S. consumption and investment, we’ve got a problem.

The last chart that I’ll just put up just shows inflation performance in a number of countries and what we see is standing out--Argentina, Venezuela--standing out as high inflation countries with really poor policies.  I’ll just end by saying that the Argentine inflation figure might be somewhat fictional.

Megan Davy:  Nancy Lee is a visiting fellow at the Center for Global Development where she works on addressing constraints to growth and income convergence in the Western Hemisphere through regional integration.  Ms. Lee joined the Center for Global Development from the U.S. Treasury Department where she served most recently as deputy assistant secretary for Europe, Eurasia, and the Western Hemisphere, overseeing the Treasury’s engagement with eighty-six countries. 

A focus of her recent work in Treasury was expanding access to finance to small businesses and catalyzing more private finance for infrastructure in Latin America and the Caribbean.  From 1997 to 1999, she was the Treasury’s director for Central and Eastern Europe.  Previously, she was director of the office for the Middle East and Central Asia and deputy director of the office of the office for Asian and Near Eastern nations, where she helped launch the APEC finance ministers’ process.  Ms. Lee.

Nancy Lee:  Thanks very much.  I, too, am honored to be on this panel with Anoop Singh with whom we worked very closely during very difficult periods during the financial stresses of the early part of this decade; with Roger, my very highly esteemed and well-regarded colleague from government; and with Desmond.  I’ve learned to listen very closely to Desmond’s prognostications.  Desmond was a very early predictor of the significant risks associated with the U.S. housing price run-up, both for the financial system and for the real economy.  I have to say, he was greeted with considerable skepticism on the part of the economic establishment in this town.  He proved to be more right than, perhaps, he would have wished given the problems we’re associated with. 

But let me start by saying that even if the relatively negative scenario that Desmond has laid out does not materialize and a benign outcome for the U.S. economy and the global economy emerges, I think this is a period of stress testing for the regional authorities--for the regional authorities in this region and for other emerging market regions because of the combination of a significant slowdown in growth, particularly for this region and significant inflationary risks. 

The period ahead will test the resolve of the monetary authorities, as Anoop pointed out.  It will expose the ongoing fiscal weaknesses that have plagued this region, and in particular, I think it will highlight the very high costs of the very slow progress in what might be called supply-side reforms in this region.  Without the right policy response, the effect on the most vulnerable groups--the poor and the near-poor--could be significantly negative.  And as Anoop pointed out, it would be a huge step backward, not to mention politically explosive, if the progress that these groups have recently achieved were reversed.

I’d like to do two things this morning.  First, very briefly assess the positioning of the region – on the one hand to fight inflation and on the other hand to sustain high growth.  I’m going to generalize across the region.  Some countries, as Desmond has pointed out, really don’t fit these generalizations.  And go very quickly since some of this ground has been covered by Anoop.  And the second thing I want to do is offer up four policy priorities, which I think make sense for the region at this time.

The first general point I want to make is that I actually think this region is considerably better positioned to fight inflation in the period ahead than it is to sustain high growth.  In 2002 and 2003, monetary authorities in this region faced the very serious challenge of preventing a translation of the exchange rate depreciation of the time into a sustained reignited inflation.  And I think they passed that test with flying colors.  Now they face the test of preventing the transformation of very high commodity prices into an uptick in core inflation, which, so far, has remain relatively subdued for this region. 

They’re doing fairly well so far, as others have pointed out.  I think it’s really striking, given the history of this region, that the overachievers among large emerging markets are now Brazil and Mexico, which are keeping inflation in the five percent range and performing considerably better than China, than India, and than Russia.  So what’s changed on the monetary and financial side?  I think Anoop has really reviewed it, and Desmond, as well. 

Monetary authorities are considerably more credible.  Inflationary expectations have really very much benefitted.  In terms of the financial sector itself, it’s healthy in this region.  That’s not true in all emerging market regions.  Banks are profitable.  They’ve benefitted from foreign participation.  And with the decline in external debt and public debt, generally in this region, the financial sector is finally turning its attention to the private sector, particularly consumer lending, which has generated a substantial share of the growth.

Securities markets are healthy in this region.  In some cases, emerging markets in this region are global leaders in market infrastructure in things like strong standards for firm disclosure, strong standards for securities trading, and strong shareholder rights.  Brazil and Peru have now joined the small but growing group of countries that have achieved investment-grade ratings in this region.  But most importantly, in my view, the monetary authorities in this region have used exchange rate flexibility as an important part of their inflation fighting arsenal, managed exchange rate flexibility to manage some of the risks that Desmond mentioned. 

I think, though, overall this is, perhaps, the single most important advantage that emerging markets in this region have over emerging markets in other regions that have pursued less exchange rate flexibility.  The countries in this region that have experienced gradual exchange rate appreciation over a period of time are now less subject to the very difficult market dynamics of very sharp exchange rate adjustments, which I think may prove very difficult for other economies in other parts of the world.

Turning briefly to growth, most analysts expect a sharp adjustment in growth for this region even under a relatively benign scenario.  Private sector analysts expect growth for the region to be around four percent this year; the IMF, I think, somewhere in the four and a half, four point four percent range.  So what has happened to growth fundamentals?  Here, I think, I very much agree with the Anoop – commodity dependency is still very high, much higher in most other emerging market regions.  Investment ratios are extremely low.  In fact, the ratio of investment to GDP is twenty-one percent in this region.  It’s the lowest of any emerging market region around the world, including Sub-Sahara and Africa. 

And productivity growth remains disappointed, even relative to productivity growth in previous expansionary periods.  The reasons are not hard to understand.  The investment climate in much of the region remains exceptionally burdensome.  The World Bank in its 2008 report has indicated that this region ranks last of any region in the world on reform progress on doing business indicators.

Fiscal policies, unfortunately, have not contributed much to growth fundamentals.  Public investment in infrastructure is still relatively low.  The quality of education spending is still relatively weak.  And spending and tax systems in this region do very little to reduce inequality, which economists are finding is, in and of itself, a significant drag on growth.  So I think the legacy of this whole period, in the sort of post-2002, 2003 period will be viewed much more favorably on the inflation side than on the long-term growth side.

So let me get to the four policy indications that I draw from this background.  Number one is to avoid overburdening monetary policy.  Monetary authorities in this region are going to have to focus very single-mindedly and resolutely on reducing inflation in the period ahead, as Anoop was pointing out.  This means they need some cooperation from fiscal policy, but they also will likely need some political protection from domestic critics of exchange rate appreciation, particularly on the exporting side.  It’s absolutely true, as Anoop has pointed out, fighting inflation is pro-poor in this region.  If there was a region that demonstrated that principle, Latin America is it.

Number two, provide targeted help for the poor.  And, I think, Anoop has very eloquently described that you can provide help to the poor while, at the same time, maintaining macroeconomic stability.  The poor may well, in this region, be subject to what might be called a quadruple whammy - high and sustained food prices; high and sustained energy prices, which hurt poor farmers’ ability to respond, to engineer a supply response, because they’re paying much higher prices for fertilizer and for diesel fuel; slowing remittances.

So far it’s a slowdown, it’s not a decline, but if the U.S. economy gets worse, as Desmond mentioned, it could easily become a decline; and the last part of the whammy is the slowdown in growth itself.  It was only when growth in this region topped five percent that you started to see formal job creation in the region really pick-up.  So I think we have to be prepared that the likelihood that formal job creation that formal job creation will once again subside and the large share of employment that is in the informal sector will persist.

The third priority is a focus on supply-side policies, which has, I think, as a lot of people have pointed out, been relatively low on the agenda in this region.  In the long-term, medium-term that means a lot more investment in infrastructure and it means a lot more effective spending on education.  But in the short-run, it could easily mean a focus on microeconomic policies--the tax, regulatory and legal environment, which now makes it so difficult in this region to increase investment. 

Low and middle economies in the rest of the world have demonstrated that you can engineer a very positive shock to investment in a relatively short period of time if you address these microeconomic policies.  And in this region, Chile, Columbia, Peru, Mexico, Guatemala have all achieved significant reforms and, hopefully, provide some positive demonstration effect for the rest of the region.

And, finally, I believe this region needs to refocus on economically meaningful integration for the hemisphere and for the region.  Despite the political forces that are arrayed against integration in much of the region, this is not the time on integration.  The experience of Europe and East Asia suggests that integration matters a lot for growth and it can be a very important determinant of rapid income convergence.  This is the time, however, to start thinking about integration in ways that go beyond trade.  I think we need to move away from focusing on integration only as a question of trade and more toward the kinds of issues which are binding constraints on growth in this region, particularly investment.

You have in your packets an idea that we’re working on at the Center for Global Development for something we’re calling a Regional Investment Agreement.  It’s different from bilateral investment treaties.  It’s aimed at reducing barriers to investment that confront both domestic investors and foreign investors.  The idea is to have a multilateral effort to collectively set standards for legal, regulatory and tax environments; to do a better job of systems for starting businesses; obtaining licenses; dealing with Customs; registering property. 

This approach is made possible because there’s been a very rapid advance in the world’s ability to measure investment climate indicators in the same way that we’ve been able to measure trade indicators.  So now it’s feasible to set standards for reducing investment barriers in the same way that we have reduced trade barriers.

The general point I want to leave you is that the supply response, and particularly microeconomic policies, have to rise much higher on the agenda of the region if we’re to get through this difficult period.  Thanks a lot.

Megan Davy:  Thank you very much for that presentation.  I’m going to move on to Roger Noriega.  He is a visiting fellow here at AEI, coordinating the Institute’s program on Western Hemisphere issues.  Twice appointed by President George W. Bush, and confirmed by the U.S. Senate, and with a ten-year career on Capitol Hill, Ambassador Noriega’s breadth of experience offers strategic vision and practical insight on the Americas. 

As assistant secretary of state for Western Hemisphere affairs, he managed a three thousand person team of professionals in Washington, D.C., and fifty diplomatic posts to design and implement political and economic strategies in Canada, Latin America, and the Caribbean.  As U.S. permanent representative to the Organization of American Studies Roger coordinated complex and sensitive multilateral diplomacy in a thirty-four member international organization to bolster OAS efforts to promote trade, fight illicit drugs, and defend democracy.

Roger Noriega:  Thank you very much, Megan.  This is a real challenge to follow these two excellent panelists, but I have no choice but to do that.  I can’t abandon field.  I want to discuss a little bit about the various forces at work in the region and how policymakers are going to react, I believe, to the challenges in coming years.  The paper that’s in your packet that Megan and I co-authored really concludes that while we believe that there will be relatively minor symptoms in Latin American Caribbean countries from the U.S. economic downturn, thanks in large part to reforms undertaken in response to previous financial crises as well as continued high commodity prices and that will continue to buoy export markets, the crisis will also expose some of the lingering weaknesses in the region’s economy, and it could provide an impetus for reform to complete the unfinished business that the region faces. 

One of the interesting factors that we have noticed in countries like Brazil and Argentina, in particular, is that there seems to be a moral hazard for bad policies that submerge in the Americas.  Countries like Brazil and Argentina that have dealt over the years with remarkably high levels of inflation, have left populations that are terrified by the prospects of going back to those boom and bust cycles.  You see an example in the case of Brazil and President Lula of policymakers that have managed to stop this boom and bust cycle that has typified the evolution of the Brazilian economy. 

And you see in Argentina the popular reaction to poor policies being implemented by the recent administrations.  It’s really sort of interesting.  These people see the price control policies--the taxing of the export, agricultural export market--that President Kirchner has implemented, and the reaction has been public rejection.  So it’s sort of interesting to see that there may be this constituency for sound economic policies that sort of undergirds where policymakers could go in the region. 

To their credit, in recent decades many Latin American countries have poured the foundations for more responsible fiscal policies--made inflation targeting a policy priority and established regulatory frameworks for more modern and competitive financial systems.  They stand to reap the benefits of these sound policies now in the turbulent months ahead.  Some observers contend that governments did not take full advantage of the optimal economic environment at the start of this decade by enacting more robust, integral and consequential reforms. 

Unfortunately, reform fatigue in the rise of populism have overshadowed the unexpectedly favorable conditions of the last few years and led many policymakers to lose their nerve in pressing forward with the central reforms.  Now a global financial turbulence in a more virulent strain of protectionism might erase many of these favorable factors that made some of the recent reforms possible.  And governments might focus most of their efforts once again on treating the immediate symptoms rather than remedying the underlying vulnerabilities in their economies.  One can hope, and I tend to be optimistic, that as policymakers react to the short-term effects of this latest global downturn, they will recognize that past reforms have actually mitigated the impact of this crisis and that sound policies are always worth the trouble. 

Indeed, the current turbulence might just be the timely reminder that some governments need to complete the unfinished business of retooling their economies to be more open, competitive, resilient, and, at the same time, more just.  On the other hand, the same windfalls from high commodity prices that will help a number of regional economies ride out the current prices, might also lead otherwise intelligent policymakers to postpone reforms. 

Either way, the inescapable fact is that much remains to be done in the region to retool their economies in order to sustain growth over the long-term.  The essential ingredients to sustain growth are strengthening the rule of law in central institutions; improving transparency in these economies; and investing in education, all of which are needed to attract capital and put it to effective use in these economies.

While fiscal windfalls can support sustained social spending or transfer payments to the very fore to address the impact of inflation, for example, such short-term activities are no substitute for the systemic change that extends political power and economic opportunity to those on the margins so that they can literally work their way to the middle of their economies.

What do we mean by systemic change?  Nancy has certainly referred to some of these issues this morning.  The rule of law is essential to building a modern state that can apply the rules of the game without fear of favor, and which is really indispensible in building a modern economy.  Fighting corruption, eliminating state-sponsored privileges, streamlining judiciaries and bolstering security are essential responsibilities of any accountable government, and this is the time for them to press forward on these fronts. 

Regulatory reform that makes it easier for entrepreneurs - foreign and domestic--to start businesses is also a low hanging fruit for reformers.  Small and medium enterprises are the building blocks to any modern economy, large or small.  They are able to identify demand, access credit, generate commerce, and create jobs.  Outdated and unnecessary regulation stunt the growth of any new business, driving them into the informal economy and, thereby, slowing growth in the developing world.

There are many, many checklists on how to do this--how to make it easier for these enterprises to become the engines of growth, and this is the time for Latin America to continue to work through that checklist.  Any government that is serious about sustained broad-based growth must treat modernization of this kind as an urgent priority.  Policies that secure capital and property rights will attract direct investment to sustained growth and allow financial institutions to provide credit and other services more effectively to these small and medium enterprises, and to individuals, in greater need of credit during economic downturns.  This includes, of course, first class intellectual property protections that will encourage high-tech direct investment and invite technology [tape skips] that will enrich the economy in many ways.

What are some of the areas of concern in the region that we see?  Despite the existence of immense hydrocarbon deposits in the Americas and the benefits of high prices for these commodities, many countries adopt the policies [audio glitch] discourage this, and therefore, prevent national proxy sector over the [audio glitch] term.  Pricing and marketing regimes that prevent private companies from recovering their investments have strangled the sector in some countries and created inexplicable shortages and even blackouts in states rich with energy potential. 

For example, price controls in Argentina and the energy sector have sown the seeds of disaster, I think, for that economy just as it is seeking to consolidate its recovery.  Bolivia’s self-inflicted political woes have discouraged foreign investment despite the desperate need for vast amounts of capital and specialized technology to exploit and market its impressive deposits of natural gas.  In Venezuela, President Chavez has replaced able technocrats with partisan loyalists and squandered billions of dollars in revenue in unaccountable and overtly corrupt spending at home and abroad, which has wreaked havoc in the country’s state-owned oil company. 

Mexico’s polarized politics, populism, and nationalism have stalled even tentative reforms proposed by President Felipe Calderon to open its underperforming sector to foreign investment technology.  Mexico’s national budget depends on petroleum revenue for forty percent of its spending, as in too many countries.  As oil prices rise, politicians plow the windfall into discretionary popular spending programs rather than reserve the funds for tougher days, or invest it back into the energy sector. 

Chile has a decades older -- [indiscernible – audio glitch for 11 seconds] –- in sound, integral, social or infrastructure programs should be part of any country’s development plan.  As a matter of fact, the anti-poverty programs that targeted spending targeted subsidies and transfer payments in Brazil and Mexico, for example, might actually be an essential part to riding out these economic hard times and sustaining sound policies on a broader scale. 

By simplifying tax codes and making them more transparent and by designing codes to prevent evasion, the private sector investor class can make better decisions for growing their businesses, which in turn will provide jobs, which is always the best social program and generally -- [indiscernible – audio glitch for 25 seconds] –- even nations rich in oil or other commodities are discovering that there is no substitute for responsible leadership.  The others are benefitting today from a little bit of luck and, more importantly, years of hard work, learning the essential economic lesson that the harder they work, the luckier they get.  Thank you very much.  [Applause]

Megan Davy:  I want to thank all of our panelists for the really good and, I think, really informative insightful remarks.  We’re going to go ahead and turn to the audience for Q and A.  Let me just please remind everybody to please wait for the mic and be sure to state your name and affiliation.

Barbara Bowie-Whitman:  Barbara Bowie-Whitman.  I’m an independent consultant formerly with State.  I used to work for Roger.  Nancy, I’m intrigued with your idea of a hemispheric or regional investment agreement.  It seems to me that the differences in how we view investment and the things we ought to agree upon in investments, in any kind of compact, bilateral or regional, are one of the major reasons we didn’t ever get to a trade agreement among thirty-four countries in the time that we had set it out.  With Brazil, the stated objections were a whole series of things, but when you get down to it right now, our differences in how we approach investment are very important.  So I guess it’s a two-prong question.  Do you see an investment agreement as a precursor to getting back to the trade table or do you think we can do both at once or how do you see it evolving?

Nancy Lee:  Thanks, that’s a great question.  It seems to me it’s a sort of three part question.  Part number one, just to phrase it in stark terms is why would you think we could possibly do something like this since it’s one of the most difficult issues?  Part number two, is it a way to substitute for trade or three, or to move back to trade?  The idea, actually, is quite different from what people conventionally think of as investment agreements. 

It is not particularly focused on cross-border investment, so it’s not focused on the things that you normally think about--free transfers, the right of establishment, eliminating performance requirements, sort of ex-appropriation [sounds like], cross-border ex-appropriation, rather it is an attempt to get on some of the most significant investment barriers in this region that effect both domestic firms and foreign firms.  And this is basically the tax system, which is burdensome administratively, and also in terms of rates, at least for businesses, the regulatory system--product regulation, labor regulation--and the legal system.  It just so happens that, essentially, because of the efforts of the World Bank, we now have dozens, if not hundreds, of investment climate indicators that measure very specific aspects of the tax, legal and regulatory environment. 

So we have a capacity to measure, very specifically, in a way that’s consistent across countries how high those barriers are across various systems.  So the idea is basically to use the same kind of approach that we used in trade agreements.  You can set standards for various indicators and you can decide multilaterally how far countries are willing to commit in terms of moving their indicators towards whatever the agreed norm is.  So it’s different.  And it relies on the notion that countries want to do this anyway but for various political reasons, it’s hard to do it. 

And a multilateral agreement will help.  It’s the same kind of rationale as trade agreements.  Trade reform is good with or without a multilateral agreement, but multilateral agreements have helped move the reform agenda forward and they also lock in reforms.  In answer to your sort of second and third questions--this is not a substitute for trade liberalization, but in our view it very much increases the benefits of trade liberalization.  One of the problems with trade liberalization is that it hasn’t actually produced the benefits of the region that everybody had hoped, and that’s largely because there are a lot of investment climate issues that prevent the supply response from lower trade barriers.  Europe understood this lesson very well, and that’s why they moved from the customs union to the common market.  So it is not a substitute; it’s rather a way to kind of turbo-charge the benefits, particularly for investment.

Megan Davy:  The gentleman in the front here.

Francis Skrobiszewski:  I’m Francis Skrobiszewski.  I’m a director of U.S. Polish Trading Council.  My question is directed to Nancy Lee.  I was also vice president of Enterprise Funds for fifteen years and so it kind of wraps around some of those issues.  You mentioned the impacts on the poor are significant and they could be explosive so, in essence, we have to provide economic opportunity to the lower classes.  And then you also spoke about the microeconomic policy reform to, essentially, help businesses.  Roger Noriega, Ambassador Noriega, also emphasized the need to stimulate the small and medium-sized businesses as building blocks for the economy. 

What I’m wondering, in Eastern Europe at the onset of the transition, Congress provided for Enterprise Funds to put capital quickly into the hands of entrepreneurs, and we helped build the policy framework from the ground up as opposed to, we had policy framework being dropped on, but the two came together.  I’m just wondering, I don’t see the source as a capital, but private capital isn’t going to go in when you don’t have the infrastructure, when you don’t have the conducive policy, so it seems to me that there needs to be some role for public capital, and public capital less professionally deployed on commercial terms, though, as ours was.  Can you speak to that at all?  If that’s a viable possibility?  I know there are a lot of small microenterprise programs, but they’re a little bit different.  Thank you.

Nancy Lee:  Also a very good question.  The questioner may be too modest to say that the Polish Enterprise Fund was probably the most successful of all of the Enterprise Funds that the United States government launched in the transition.  In fact, it was liquidated and the proceeds went back to the Treasury Department, so we view the Polish Enterprise Fund very favorably.  And I am very much influenced by what happened in the transition economies with respect to looking at this region. 

At the time of the Enterprise Fund, you did need public capital for investment.  You really didn’t have a financial system, a commercial financial system--any kind--not commercial banks, not any other kinds of capital markets which could intermediate capital to the private sector.  So there was every reason to set up Enterprise Funds. 

That’s less the case in this region.  It really does have a pretty sophisticated formal financial sector.  That doesn’t mean, however, there isn’t a role for public institutions, particularly the international financial institutions, OPEC, and the United States to catalyze private capital by sharing some of the risks and by doing some kinds of capacity building that help banks lend to new kinds of customers like small businesses. 

And that’s why, at Treasury, we launched last year a new program which was a partnership between OPEC, the Inter-American Development Bank, and the Treasury Department to share some of these costs and some of these risks.  And so what we’re hoping is that a little bit of public money will catalyze a lot more private money.  But we’re basically working through financial institutions in the region so it’s not an Enterprise Fund in the sense that public money is being invested directly in equity markets.  What it is is using public money in a more catalytic way to unlock private money. 

But the one other thing I wanted to say about transition economies is they did really focus on these investment climate issues, partly because a lot of them were joining the European Union, and they had to do legal and regulatory reform, but partly because they had big problems of tax evasion.  There were no countries in the world that had more tax evasion than the post-communist countries.  And so they came up with very simple tax systems like flat taxes--relatively low flat taxes. 

And the effect of those systems was essentially to convince potential tax payers that is was actually easier and lower cost just to pay the taxes than it was compared to the risks of evading taxes.  So I’m a big believer that one of the things you have to do in situations where you have very high rates of tax evasion is to create very simple systems which people then regard as less burdensome than not paying taxes.  So I think that is a lesson for this region, and I think some of the things that these countries had to do when they joined the European Union are also lessons for this region.

Federica Narancio:  Hello, my name is Federica Narancio.  I’m from the McClatchy News Service.  I wanted to ask Roger if you think that the protests in Argentina and Venezuela could lead to a bigger political crisis in response to the inflation and, if so, how do you think political crises of those countries could affect the rest of the region?

Roger Noriega:  Well, I think they--they’re cautionary tales, what’s happening in Venezuela and Argentina, that might actually reassure policymakers in other countries--Brazil, Colombia, Chile, Peru--that they’re doing the right thing.  That by respecting market forces, by dealing with poverty in responsible ways that don’t undermine the integrity of your economic program, you can actually keep the ball in the air politically. 

On the other hand, if you slap the invisible hand of the market, you end up with shortages in Venezuela, food shortages; in Argentina, if you tinker with prices you end up with energy shortages; and the economic dislocation and the political problems that go along with these things.  So they may actually be teaching the rest of the region a lesson on how not to run an economy.  And so it may be a favorable result in the long run. 

In Venezuela and Argentina, internally, who knows?  I think that what you may end up with in Argentina are chastened policymakers.  Nobody wants to see anything dramatic or drastic happen politically there.  They don’t want to go through the trauma of any kind of premature change in government, but at the same time you see this popular rejection of these poor policies that the Kirchners have adopted.  In Venezuela, the wheels are really coming off there.  We’re talking about a hundred and thirty-five dollar barrel of oil.  These prices can sustain almost anything, you would think. 

But having said that, it’s just such the systematic dismantling of the checks and balances within that system have brought about a situation, I think, where the dissent that is there and growing can’t be handled in a transparent, predictable, and responsible way.  And so you may see desperate people resort to desperate measures.

Alexandra Panait:  Hi, my name is Alexandra Panait.  I’m from Eisenhower Institute.  I’m currently an intern, but I’m just a student in America [indiscernible].  I’m from Romania.  First of all, all of the speakers mentioned the importance of education, which, of course, is like an engine for growth in every country, especially like transitional economies.  I know especially Latin America has a problem with the lost under-education [sounds like] compared to, let’s say, Eastern Europe.  The returning [sounds like] is not high, so basically most students like my age--twenty-something years old--would emigrate to America and not return back home, although their economies need them. 

So my question would be how do you see investment in education given that there’s no incentive to return home?  And my second question would be--whenever I hear Latin America, I always draw a parallel between that and Eastern Europe, particularly Romania and Bulgaria and all these Baltic countries that have recently joined the European Union, and although the funds are there to build infrastructures and everything, there are blocked because of the corrupt leaders, because the economy is not doing really well, and the public policies. 

People do not know--there’s no leadership to actually use those funds.  So, basically, although we are only with the name in European Union, that’s it.  We are just learning by doing.  So, basically, we are very dependent on the Western Europe.  My question would be--do you see Latin America learning by doing, as well, as not being dependent on U.S. or other global economies or do you want Latin America to build itself by itself with no external help?  Thank you.

Nancy Lee:  First of all, Romania was one of the countries that has gone through very difficult periods, and whatever the problems now in terms of qualifying for EU aid, it really has been a remarkable transition in Romania in terms of fixing some chronic macroeconomic problems and increasing growth.  And just from my experience traveling to Romania, I think it’s an exceptionally well educated population.  I’ve spoken to a number of highly smart and well educated young people in Romania. 

First, on the question of education, the basic problems with Latin American education do not seem to be a result of low spending levels.  If you compare spending in Latin America to other parts of the world--high income parts of the world and the emerging markets--spending levels are not that difficult.  This is clearly a question of what the money is spent on.  I think, in some cases, there is a lot of emphasis on teachers’ salaries and not much emphasis on anything else, including teacher performance. 

And the specific problems in Latin America are a lack of preschool education, low completion rates for secondary school and not a lot of participation at the university level, particularly by poorer parts of the population.  There are a lot of subsidies for relatively high income people to go to college, not for low income people.  So the issue on Latin America is to spread access to education and improve its performance. 

I think we are probably going to see a lot higher returns to education in Latin America, particularly university education, if Latin America manages to sustain relatively high growth.  You see in parts of Latin America--places like Brazil–-skill shortages emerging as growth generates demand for services at a much larger level than used to be the case.  So I think the returns are going to increase, and I think that’s going to mean that people are going to benefit more from education. 

What that also is going to do, as it has in the United States, is to increase inequality because the returns to higher skills are going to increase relative to the returns to low skilled workers.  That’s going to mean even more of an emphasis in spreading access to education to a broader part of the population to raise general skill levels.  I think that’s absolutely critical for Latin America.

On the question of sort of going it alone or relying on large amounts of aid, I think most European Union entrants do benefit from substantial amounts of aid.  I understand the problems with Romania and Bulgaria, in particular, but I hope that those will be overcome.  And I think aid levels will rise, and I think the aid story in Europe is quite impressive.  The goal for aid is supposed to be something like three or four percent of GDP once you join the European Union.  A lot of it goes for infrastructure, and you can see all over Europe, very clearly, the benefits of that, particularly in terms of road transport.  I’m hopeful that aid will increase. 

It is true that in Latin America we have multilateral institutions like the IDB and the World Bank, but we don’t have those massive aid levels.  But the good side of the story is, though, that we have a lot more private finance available than we used to because the financial systems in these economies are now starting to intermediate capital for the private sector.  So what we’ve got to do is use public money, catalytically, to unlock those financial flows--financial flows for infrastructure, there have got to be sort of public/private partnerships--and financial flows for newcomers to capital markets, like small businesses. 

But the other thing the region has to do is improve the quality of spending, and it has to shift more spending to infrastructure.  If you look at the emerging markets around the world that have managed to increase infrastructure, they’ve done it with a fair amount of public money, as well as private money, so that there’s just no substitute for shifting the share.  And it’s unfortunate that that didn’t happen in this boom period.

Roger Noriega:  May I comment very briefly on that, those points?  Excellent question.  I think it’s a false dichotomy that they have to either learn by doing or have U.S. help.  It has to be both, really.  At least it can be.  The essential fact is, though, that many of these microeconomic second generation reforms that we’ve all alluded to can’t be imposed by any on the outside.  They have to be done, implemented by policymakers internally.  And some of these are difficult political decisions--require difficult political decision and require political leadership--and so they have to do it for themselves.  But having said that, we, I think, used in an intelligent way, the summit process to drive all of these things that we’ve been talking about, whether it’s improving education by measuring the effectiveness of education, pushing credit into the private sector, making it easier to start a business, all of these very practical things that we brought to the Presidential summit process and tried to elevate. 

Frankly, there’s a little pushback.  A lot of that was that the Latins didn’t regard this as particularly Presidential.  But in point of fact, that’s how we got our economy, I mean, so many of the jobs, just a proportionate number of jobs in this, one of the most sophisticated economies in the world, are from small and medium enterprises.  We had to impress this upon the Latins, and I think they’ve recognized that this is an effective agenda and they’re adopting it on their own.  But we need to move together as a community, and I don’t think aid is always the answer.  As a matter of fact, it’s no substitute for people making the right policy decisions on their own. 

On education, one of the things you see in some of these middle level economies--Chile, and even Brazil--is a dearth of a management capacity.  And I think that as you develop and if you target education programs to primary and secondary, and also to practical skills in managing enterprises, I think these would be the priorities that I would identify as a lay person.

Megan Davy:  Desmond, do you have any remarks on this or any other comments you want to make?  Okay.  Should we take one more?  We’ll take one final question from the woman here.

Female Speaker:  I would like to highlight the fact that we should be more careful with, maybe, a very simplistic analysis regarding cases like the Venezuela case or the Argentine case.  It is obvious that there are reasonable concerns, like for example, how appropriate the price is controlled like when you have bottlenecks in the side, the supply side.  That’s a very reasonable concern, however, there are policies that, for example, Venezuela has applied and have been very successful and should be not ignored [sounds like]. 

I know that some people have said that the success that Venezuela has had, for example, regarding debt increase and poverty rates have been because of the oil booms.  But when you study the pattern of policies in past oil booms and the present oil boom, you will find that now there are more coherent policies.  You, for example, find really good success in the tax collection that has been increased significantly compared to other governments, with past governments. 

And you have, talking about poverty, a decrease [indiscernible-audio glitch], for example, debt was around forty percent and now extreme poverty has decreased to nine percent.  I’m not talking about Venezuela numbers.  I’m talking about ECLAC numbers--the Economic Commission for Latin America and the Caribbean.  So I think I would like to hear Ambassador Noriega, what is your opinion about social improvements that have been in some countries in Latin America regarding how intertwined [sounds like] growth and equality are?

Roger Noriega:  Right.  Well, you didn’t identify yourself, but you’re, I believe, with the Venezuelan Embassy, right?

Female Speaker:  Yes.

Roger Noriega:  Well, the ECLAC numbers, ECLAC actually depends on a government of Venezuela serving up data, so --

Female Speaker:  [Inaudible]

Roger Noriega:  No, and I haven’t read the ECLAC numbers either, but my distinct impression is that whatever social improvements there have been in Venezuela, they’ve come at a rather remarkable price--I know that in terms of political freedom and even economic opportunity.  But it’s true that a lot of countries in the region have had structural poverty and that policymakers in the past have given very little thought to how to deal with this problem.  And that lack of attention has actually produced a kind of virulent populism that you see in some countries. 

So it’s very important as we look forward that we consider the importance of dealing with poverty in a conscious way as an integral part of development strategies and not just as an afterthought.  But I would submit that the smartest way of having integrated economic development that deals with poverty is by diffusing political power and not by concentrating it in the hands of individuals; by strengthening democratic institutions, not by dismantling them; by having independent courts, an accountable, responsive Congress. 

And I think that Venezuela has, unfortunately, under President Chavez’s very personal peculiar project gone just the other direction.  I don’t think he becomes much of an example for the rest of the hemisphere.  No more so than Cuba is a better example than Chile about how to deal with poverty without having to surrender your liberties in the process.

Desmond Lachman:  I just want to go back to the point that was made right at the start that Anoop Singh emphasized, is that inflation is the cruelest tax.  It’s the tax, really, on the poor.  And if you take a look at the two countries--Venezuela and Argentina--that those are the two countries that it would seem that are following macro policies that are just letting inflation get out of control.  So one really wonders what happens--if inflation is at these levels right now--what happens when the quantity cycle turns, the exchange rate’s got to move.  You’ve been down that road before.  To me it just looks like very poor macroeconomic policies are being run, both in Venezuela and Argentina, and that they’re basically wasting an opportunity that might not come again.

Megan Davy:  Well, I want to thank our panelists.  It’s been an honor for me to be up here with you all this morning.  And I want to thank our audience, also, for your time and for your questions.  Thank you very much.  [Applause]

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