Income inequality in Latin America ranks among the highest in the world. It can be traced back to the unequal distribution of assets (especially land and education) in the region. But the extent to which asset inequality translates into income inequality depends on the redistributive capacity of the state. This paper documents the performance of Latin American fiscal systems from the perspective of income redistribution using newly-available information on the incidence of taxes and transfers across the region. The findings indicate that: (i) the differences in income inequality before taxes and transfers between Latin America and Western Europe are much more modest than those after taxes and transfers; (ii) the key reason is that, in contrast with industrial countries, in most Latin American countries the fiscal system is of little help in reducing income inequality; and (iii) in countries where fiscal redistribution is significant, it is achieved mostly through transfers rather than taxes. These facts stress the need for fiscal reforms across the region to further the goal of social equity. However, different countries need to place different relative emphasis on raising tax collection, restructuring the tax system, and improving the targeting of expenditures.
Albuquerque, Loayza, and Servén analyze the unparalleled increase in foreign direct investment to emerging market economies in the past 25 years. Using a large cross-country timeseries data set, the authors evaluate the dependence of foreign direct investment on global factors or worldwide sources of risk (that is, factors that drive foreign direct investment across several countries). They construct a globalization measure that equals the share of explained variation in direct investment attributable to global factors. The authors show that the globalization measure has increased steadily for industrial and developing countries. For the full sample of countries, the globalization measure rose eightfold from 1985 to 1999. Furthermore, in recent years developing countries' exposure to global factors has approached that of industrial countries, particularly for Latin America. Finally, the globalization measure correlates strongly with measures of capital market liberalization. Overall the authors find strong support for the hypothesis of increased market integration which implies a greater role for worldwide sources of risk. They discuss the implications of the results for public policies regarding capital market liberalization and policies directed at attracting foreign investment. This paper--a product of Macroeconomics and Growth, Development Research Group--is part of a larger effort in the group to understand international capital flows.
Using a large cross-country income distribution dataset spanning close to 800 country-year observations from industrial and developing countries, the authors show that the size distribution of per capita income is well approximated empirically by a lognormal density. The null hypothesis that per capita income follows a lognormal distribution cannot be rejected-although the same hypothesis is unambiguously rejected when applied to per capita consumption. The authors show that lognormality of per capita income has important implications for the relative roles of income growth and inequality changes in poverty reduction. When poverty reduction is the overriding policy objective, poorer and relatively equal countries may be willing to tolerate modest increases in income inequality in exchange for faster growth-more so than richer and highly unequal countries.
The Argentine crisis has been variously blamed on fiscal imbalances, real overvaluation, and self-fulfilling investor pessimism triggering a capital flow reversal. Perry and Servén provide an encompassing assessment of the role of these and other ingredients in the recent macroeconomic collapse. They show that in the final years of convertibility, Argentina was not hit harder than other emerging markets in Latin America and elsewhere by global terms-of-trade and financial disturbances. So the crisis reflects primarily the high vulnerability to disturbances built into Argentina's policy framework. Three key sources of vulnerability are examined: the hard peg adopted against optimal currency area considerations in a context of wage and price inflexibility; the fragile fiscal position resulting from an expansionary stance in the boom; and the pervasive mismatches in the portfolios of banks' borrowers. While there were important vulnerabilities in each of these areas, neither of them was higher than those affecting other countries in the region, and thus there is not one obvious suspect. But the three reinforced each other in such a perverse way that taken jointly they led to a much larger vulnerability to adverse external shocks than in any other country in the region. Underlying these vulnerabilities was a deep structural problem of the Argentine economy that led to harsh policy dilemmas before and after the crisis erupted. On the one hand, the Argentine trade structure made a peg to the dollar highly inconvenient from the point of view of the real economy. On the other hand, the strong preference of Argentinians for the dollar as a store of value--after the hyperinflation and confiscation experiences of the 1980s--had led to a highly dollarized economy in which a hard peg or even full dollarization seemed reasonable alternatives from a financial point of view. This paper--a product of the Office of the Chief Economist, Latin America and the Caribbean Region--is part of a larger effort in the region to understand the causes of macroeconomic volatility.
February 1995 Conventional analyses of the effect of terms-of-trade shocks provide a misleading view of their impact on investment and the current account, because capital goods imports are excluded from the analytical framework -- an exclusion both arbitrary and unrealistic. Conventional analyses of the effect of terms-of-trade shocks provide a misleading view of their impact on investment and the current account, says Serven, because capital goods imports are excluded from the analytical framework. He argues that such an exclusion is both arbitrary and unrealistic. Serven reexamines the consequences of permanent and transitory changes in the terms of trade in a rational-expectations model of a small open economy with intertemporally optimizing agents, and with trade in both consumption and capital goods. In this framework, the response to a permanent terms of trade improvement is unambiguous: The long-run capital stock, and thus investment, must rise, and the current account must deteriorate -- exactly the opposite of the Laursen-Metzler effect. A transitory improvement in the terms of trade raises saving but has an uncertain effect on investment. So, the impact on the current account is generally ambiguous and is shown to depend on three factors: the import contents of consumption and investment, the duration of the windfall, and the degree of intertemporal substitutability in both consumption and investment. This paper -- a product of the Macroeconomics and Growth Division, Policy Research Department -- is part of a larger effort in the department to understand the macroeconomic impact of policy shifts and external shocks. The author may be contacted at firstname.lastname@example.org.
June 1995 To analyze the probable macroeconomic impact of fiscal and monetary retrenchment in Chile, an open-economy, dynamic rational-expectations macroeconomic model is applied to data for Chile. For the past two decades, Chile has consistently pursued a course of macroeconomic stabilization and deep economic reform. But in recent years, real exchange rate appreciation and persistent moderate inflation have become key concerns for Chilean policymakers, suggesting the need for further fiscal and monetary retrenchment. Using an open-economy, dynamic rational-expectations macroeconomic model applied to Chile, Schmidt-Hebbel and Serven analyze and quantify the macroeconomic impact of fiscal and monetary retrenchment. Several features of the model are essential for a realistic assessment of the effects of fiscal and monetary policy shifts in Chile: backward indexation of wages, consolidation of the central bank and the general government, and the coexistence of (1) liquidity-constrained consumers and firms with (2) unconstrained agents whose consumption and investment decisions reflect intertemporal optimization with perfect foresight. This framework makes it possible to distinguish meaningfully between permanent and transitory policy changes, as well as between changes that are or are not anticipated. Simulations show that a balanced-budget fiscal contraction leads to a modest real depreciation, which is sharper in the short term (especially if the contraction is temporary). At the same time, this type of fiscal retrenchment causes a temporary deterioration of the current account. An orthodox money-based disinflation implemented by halving the growth rate of base money leads to a sharp real appreciation in the near term, with steep output and employment costs in the short run, but it also causes a transitory improvement in the current account. This paper--a product of the Macroeconomics and Growth Division, Policy Research Department--is part of a larger effort in the department to model macroeconomic policy in developing countries.
Solvency is an intertemporal concept, relating to the present value of revenues and expenditures, and encompassing both assets and liabilities. But the standard practice among policy makers, financial market participants and international financial institutions is to assess the strength of the fiscal accounts solely on the basis of the cash deficit. Short-term cash flows matter, but a preponderant focus on them can encourage governments to invest too little, especially during episodes of fiscal tightening. This has potentially adverse consequences for growth and, paradoxically, even for fiscal solvency itself. The paper offers an overview of the links between fiscal targets, public investment, and public sector solvency. After reviewing the international experience with public investment under fiscal adjustment, the paper lays out an analytical framework to illustrate the consequences of using the public deficit as a guide to solvency. The paper then discusses some alternatives to conventional cash deficit rules and their implications for investment and fiscal solvency.
Analyzing the experience of Mexico under the North American Free Trade Agreement (NAFTA), 'Lessons from NAFTA' aims to provide guidance to Latin American and Caribbean countries considering free trade agreements with the United States. The authors conclude that the treaty raised external trade and foreign investment inflows and had a modest effect on Mexico's average income per person. It is likely that the treaty also helped achieve a modest reduction in poverty and an improvement in job quality. This book will be of interest to scholars and policymakers interested in international trade and development.
Over the 1980s and 1990s, most Latin American countries witnessed a retrenchment of the public sector away from infrastructure provision and an opening up of infrastructure activities to the private sector. This book analyzes the consequences of these policy changes from two perspectives. First, it reviews in a comparative framework the major trends in infrastructure provision in Latin America over the last two decades. Second, it evaluates the implication of these trends for economic growth and public deficits in the region. The book shows that in most countries private participation did not fully offset the public sector retreat. The result was a slowdown in infrastructure accumulation, which entailed a significant growth cost and weakened the intended impact of the infrastructure spending cuts on public sector insolvency.