European crisis – lessons from Latin America??!!

Well we are in interesting times for sure. If developed economies need to get lessons from Latin American economies on crisis management, the world has indeed changed. Barring some concerns from Argentina, most of LatAm has stood pretty strong in this crisis.

Guillermo Ortiz (ex-Governor of Bank of Mexico and now Chairman, Grupo Financiero Banorte) gives this interesting speech on the topic.

There is an interesting graph comparing PIGS debt levels with Latin American debt levels pre and post crisis (page 11) .  Guess which Latam country resembles Greece debt levels the most…Well it is Chile which had the highest debt levels in 1980s (75%)  which rose to touch 125% of GDP levels in crisis (Greece figures are 110% of GDP and 125% of GDP).

And now we know Chile has progressed so much that is now a OECD member and has some amazing economic policy framework. So can Greece do a Chile?

Back to the paper. Ortiz points Latam did 3 things  to resolve their crisis:

  • They engaged in fiscal adjustment through IMF Stand-by Programs;
  • They stimulated growth through structural reforms;
  • And, finally, they sought debt relief through the Brady Plan.

Europe has followed the same path but has been weak. Fiscal adjustment plans are not backed by strong growth reforms and there is no Brady plan so far to help these economies. There is no real credible crisis solving policies by European authorities making markets suspicious of their intent. And then Europe does not have the option of devaluation which Latam had. Somehow Ortiz does not highlight the role of currency devaluation much.

Apart from Latam crisis of 1980s he also discusses Peso crisis of Mexico in 1994. This was a result of widening current account deficits in early 1990s and large capital inflows. The latter dried up as deficits were basically wasted on wasteful expenditure and markets soon realised this and created havoc:

Why was Mexico hit so hard? Apart from the vulnerabilities mentioned, the crisis was so acute because of a massive loss of confidence in the country and its institutions. Financing to Mexican banks was cut, and trade financing became scarce. The new administration obtained a financial package from the U.S. government, the IMF and other international organizations that helped avoid a liquidity problem that would have resulted in a systemic financial debacle.

The Clinton team came out with a solution (led by Summers and Geithner) which then made to the cover of Time Magazine as team that saved the world:

President Clinton offered a loan from the Exchange Stabilization Fund of US$20 billion that required no congressional approval. The IMF then agreed to lend another US$17 billion, an unprecedented amount at that time. Together with other funds from international organizations, the loans to Mexico added up to close to US$50 billion dollars.

At the same time, parallel negotiations with the political forces in Mexico (including the congress and the unions) were taking place Mexican authorities implemented a harsh austerity program which included higher taxes, increases in energy prices, and expenditure cuts. It was clear that substantial changes had to take place in order for Mexico to come out on the other side.

We had similar scenes then as seen now in Greece – protests etc:

And, as is always the case, big changes imply enormous risks. The negotiations were fraught with tension, conflict and challenges. However, by March, a final package and adjustment program were agreed upon. The truth is that, at the time, it was impossible to say whether the measures taken would work. Turning market sentiment around is by no means an easy task, but it is of the essence in resolving a crisis of such proportions.

Fortunately, the program did work in the end, and by mid-1995, less than a year later, Mexico was in a position to enter the capital markets for financing once again, and was able to repay both the U.S. government and the IMF years ahead of schedule. The results of the efforts set in motion in Mexico as a response to the crisis of the early 1990s are testament to the success of this strategy.

The main lesson from 1994 crisis:

In my view, the most important lesson from this episode is that recovering market credibility is crucial in the resolution of a crisis. Decisive action was what determined the positive outcome of the Mexican peso crisis. The program was designed to overshoot both in financing and adjustment, and to stay ahead of the curve. This is what allowed the authorities to enhance credibility; and this is what the actions undertaken to deal with the euro crisis is missing. The 1995 financial package for Mexico and the stabilization program that was implemented had a similar effect as the Brady Plan. They set the stage for the restoration of stability and growth.

And in case of Europe, they have mostly been behind the curve – dilly dallying and then giving mush lesser than expected. Even the measures which are given are seen as fudges soon after.

A nice perspective.

This crisis has clearly shown anything is possible in economics. Latin American countries can also give lessons on sound economic policy to countries from where all this advising started…


One Response to “European crisis – lessons from Latin America??!!”

  1. Lessons for Greece from Argentina « Mostly Economics Says:

    […] Guillermo Ortiz gave broad lessons to Europe from LatAm crisis, here is another  piece of advice from Mark Weisbrot […]

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