Honduras: Facing the Budget Challenges?

By ICEFI and CLALS*

Honduran Lempiras

Honduran Lempiras/ Alex Steffler/ Flickr/ Creative Commons

Honduras’ proposed budget for 2020 reduces support to the country’s most needy – while protecting the military and security agencies – and, particularly if the debate on priorities is not made more inclusive, risks exacerbating already high political tensions and chronic economic mismanagement. On the revenue side, the draft budget shows a drop in tax revenues from 18 percent of GDP in 2019 to 16.5 percent – which, ICEFI has found, is not justified by technical analysis of the circumstances. Government spending – excluding payment on the national debt but including transfers to funds and trusts – equaled 19.7 percent of GDP, compared to 21.5 percent in 2019. (ICEFI estimates that the average government spending in Central America in 2019 will be 18.5 percent.) This drop will affect most public entities, particularly in social spending.

  • Education faces deep cuts. The budget of the Secretariat of Education, for example, will drop from 4.85 percent of GDP in 2019 to 4.49 in 2020. Transfers to public universities are slated to be reduced 23.1 percent from 2019 levels, and scholarships are also on the chopping block – cut 27.5 percent for national and 37.5 percent for international scholarships.
  • Health spending in Honduras – the country with the highest poverty rates in Central America – will decline from 2.39 percent to 2.37 percent at a time that inflation is more than 4 percent. The budget for Infrastructure and Public Services will be hit hardest – cut from 0.82 percent of GDP to 0.40 percent. Capital expenditures or investment will decline 33.5 percent year on year, including 38.5 percent from machinery and equipment and 34.6 percent for construction.
  • One of the only government sectors seeing increases is in the military and security, according to ICEFI. The 2020 budget proposes a 39.6 percent increase from 2019 on military and security equipment.

At first glance, the budget would appear to produce a surplus in 2020 of about 0.4 percent of GDP, which is double that ICEFI estimates for 2019. But factoring in the transfer of resources to the funds and trusts – a more reliable way of tracking fiscal behavior – the deficit will actually be 1.5 percent of GDP. That’s lower than ICEFI’s estimate of the deficit this year (1.9 percent), but it is achieved at the expense of the wellbeing of a majority of the Honduran population.

If approved and implemented as proposed, the budget will set back several strategic goals that the Honduran government itself has set. The budget confirms the government’s desire to reduce the public deficit principally through cuts to social spending and some capital expenditures – even though the approach contravenes commitments made under the UN Convention of the Rights of the Child and General Comment No. 19 (2016) on public budgeting for the promotion of children’s rights, which establishes that states should not deliberately adopt regressive measures that undermine child’s rights.

  • Although some provisions of the budget in principle could expand production of goods and services, they do not clearly point to either social inclusion, especially in terms of gender, age, and ethnicity. Budget allocations dedicated to attention to women are very low, equaling barely 0.19 percent of all spending. Neither does the budget focus on achieving any particular Sustainable Development Goals (SDGs).

The transparency and inclusiveness of the budget debate in the Honduran Congress will be crucial to determining the longer-term impact of this budget on human rights and the provision of public goods and services to the most vulnerable Hondurans, including children, adolescents, and women. Executive and Congressional decisions on the budget will shift the country’s path toward prosperity and governance – or continue down a path of instability and tension. More breaks for those capable of paying taxes, while cutting essential services to those who cannot, will be a step in the wrong direction. At a minimum, Honduran leaders should demonstrate the benefits of such moves will outweigh the costs. The legitimacy and effectiveness of the Honduran budget will depend on a broad, inclusive, and honest debate.

November 26, 2019

* The Instituto Centroamericano de Estudios Fiscales conducts in-depth research and analysis on the region’s economies. This is the second in a series of summaries of its analyses on Central American countries.

Argentina: Market Meltdown Can Be Halted

By Arturo Porzecanski*

From right to left, then-president Cristina Ferdandez de Kirchner, then-minister Alberto Fernandez, and other then-ministers

Ministers of Cristina de Kirchner / Wikipedia / Creative Commons / https://es.wikipedia.org/wiki/Archivo:Ministros_de_Cristina.jpg

The unexpectedly strong performance of the Alberto Fernández-Cristina Fernández de Kirchner (FF) ticket in Argentina’s August 11 presidential primaries has triggered a stampede out of the country’s currency, stocks, and bonds, but FF hold the key to staving off a full-fledged crisis. If the confidence of local and foreign investors is not recovered soon, the market rout has the potential to induce runaway inflation, plunge the economy into a deep recession, and cut off domestic and international financing for both the outgoing and incoming governments, potentially leading to a default.

  • The FF Peronist ticket’s 15.6 percentage-point margin of victory over President Mauricio Macri and his companion was foreseen by none of the pre-election polls. The wide gap shocked investors because it indicates the Fernández duo could win in the first round in the October 27 general election, avoiding a second-round ballot on November 24 in which the pro-market Macri was thought to have a better chance. The coattail effect of FF helped allies in provincial and local primaries around the country. With likely majorities in one or possibly both houses of congress, FF would have a powerful government that could implement much of its agenda, for better and for worse.

Now the challenge is to stop the vicious cycle of capital flight, currency depreciation, accelerating inflation, and plunging economic activity sparked by the electoral results. Failure to do so sooner rather than later will make it very difficult for the government to refinance its maturing short-term debts, and the Central Bank will likely experience a steady drain of its international reserves. In that scenario, the IMF, which has been sending big checks to Argentina every three months, would probably not send the next one in late September.

  • The Macri administration has announced some palliative measures (e.g., a 90-day freeze in gasoline prices and a tax exemption for food purchases), and the Central Bank has tightened marginally monetary conditions. But the government leadership team is powerless to restore the investor confidence that has evaporated.

Given his clear frontrunner status, Alberto Fernández could play a crucial role in reversing the trend. During eerily reminiscent circumstances in Brazil in mid-2002, local and foreign investors were increasingly worried that Luiz Inácio “Lula” da Silva, who was running strong in the polls in his fourth presidential campaign, would end the market-friendly policies of the outgoing Fernando Henrique Cardoso – including a break with the IMF, from which Brazil had been borrowing.

  • Worried about potentially inheriting an economic and financial mess, Lula made a public statement – he called it a “Letter to the People” – making clear his commitment to sound fiscal and monetary policies and the rule of law. He wrote about a “new social contract capable of assuring economic growth with stability,” one of whose premises was “naturally, a respect for the country’s contracts and obligations.” He followed those words with concrete actions. Two months before the elections, he gave his blessing to a new IMF program committing the next government to maintain, with minor modifications, Cardoso’s austere fiscal and monetary policies.

Lula’s actions after his election, including putting a market-friendly and popular mayor in charge of his transition team and choosing a career private-sector banker to run the Central Bank, provide a path that Alberto Fernández could follow as well. Under Lula, the Brazilian Central Bank felt supported in its all-out effort to extinguish the flames of inflation and to buttress the currency. Interest rates were thus hiked as needed before and after the October 2002 elections. He initiated confidence-building meetings with investors before taking office and reassured lenders and investors, both in Brazil and abroad.

  • So far, Alberto Fernández is denying any responsibility for the developing financial and economic crisis, blaming Macri for all that’s gone wrong. But unless he makes announcements that give confidence to local and foreign investors, he will inherit a mess.

August, 22, 2019

*Dr. Arturo C. Porzecanski is the Distinguished Economist in Residence at American University and a member of the faculty of the International Economic Relations Program at its School of International Service. This article is adapted from an essay he wrote in Americas Quarterly.

EU-MERCOSUR: Does Their New Association Agreement Mean Much?

By Thomas Andrew O’Keefe*

29/06/2019 Coletiva de Imprensa UE-Mercosul

Press conference about the trade agreement between the Mercosur and the EU / Palácio do Planalto / Creative Commons

After nearly two decades of intermittent negotiations, the European Union and the four core MERCOSUR nations (Argentina, Brazil, Paraguay, and Uruguay) have finally inked a trade agreement, but its real impact won’t be felt for years, if ever. When the negotiations began in the mid-1990s, the EU was the largest trading partner of the MERCOSUR countries, and the United States was number two. Today China is in first place, the European Union is second, and the U.S. is fourth, behind intra-Latin American trade (EU investors, however, continue to have the largest stock of foreign direct investment assets in the MERCOSUR region). When ratified, the EU-MERCOSUR Association Agreement, signed in Brussels on June 28, will exempt a little more than 90 percent of two-way trade from tariffs.

  • About 93 percent of MERCOSUR exports will eventually obtain duty-free access into the EU market, the bulk as soon as the agreement comes into effect. Agricultural commodities such as beef, chicken, corn, eggs, ethanol, honey, pork, rice, and sugar only get reduced duties, with many also subject to quotas. Another 100 MERCOSUR agricultural items are completely excluded from any type of preferential treatment.
  • Some 91 percent of European exports will get duty-free access to MERCOSUR, but gradually as tariffs are reduced over a 10-year period. The phase-out is over 15 years in the case of European automobiles, furniture, and shoes. MERCOSUR tariffs on the remaining 9 percent of primarily EU manufactured goods will remain in place permanently.
  • The agreement offers service providers from any signatory country full access to the markets of all the other signatory states.

MERCOSUR showed greater flexibility with the EU on agricultural subsidies than it had with the United States, a position that contributed to ultimate rejection of the Free Trade Area of the Americas (FTAA). Subsidies in the EU-MERCOSUR agreement are permitted if “necessary to achieve a public policy objective.” The MERCOSUR countries also capitulated on the use of anti-dumping tariffs on intra-hemisphere trade. The new accord, however, does authorize governments to impose a duty that is less than the margin of dumping if it adequately removes injury to the affected domestic industry. It also includes provisions for ensuring that sanitary and phytosanitary (SPS) measures as well as technical norms are not abused and become disguised impediments to free trade, although it permits enforcement of the European “precautionary principle” notion to restrict the importation of genetically modified food, for example, where the risks to health are not scientifically conclusive.

The agreement – now being “legally scrubbed” and translated into the EU’s 23 official languages – faces an elaborate, multi-year ratification process in the EU, where individual countries and the European Parliament must approve it, as well as each MERCOSUR government. Agricultural forces are already lining up in many European countries in opposition. In the meantime, the accord’s greatest impact is a signal by Brazilian President Bolsonaro and Argentine President Macri that they’re making progress on their stated objective to return MERCOSUR to its original trade focus – in contrast to their predecessors – and to claim an economic “victory” when growth in both countries remains stagnant.

  • Despite the flexibility MERCOSUR showed on agricultural subsidies and anti-dumping, its main sticking points with the United States in the FTAA, a free trade agreement with the United States seems remote as the Trump administration – in contrast to the Europeans – is unlikely to offer meaningful concessions based on the lesser developed status of the MERCOSUR countries. Neither will the Association Agreement with the EU reverse or even slow the region’s shift toward trade with China and the rest of Asia.

August 6, 2019

* Thomas Andrew O’Keefe is the President of New York City-based Mercosur Consulting Group, Ltd. and a lecturer at Stanford University. He is the author of Bush II, Obama, and the Decline of U.S. Hegemony in the Western Hemisphere.

Cuba: U.S. Sanctions Underscore the Need for Meaningful Reform

By Ricardo Torres*

Cruise ship at Havana Harbor in April 2018/ kuhnmi/ Flickr/ Creative Commons

Washington’s new measures to tighten the embargo will hurt the Cuban people, especially the private sector, but Havana has little choice but to double-down on reform and make its economy more efficient and independent. Holding Cuba responsible for Venezuela’s resistance to U.S. regime-change policies in that country, and for alleged “acoustic” incidents harming U.S. diplomats in Havana, U.S. Secretary of State Mike Pompeo and National Security Advisor John Bolton last week announced steps that, taken together, amount to almost full reversal of the engagement that former Presidents Barack Obama and Raúl Castro announced four and a half years ago, in December 2014.

  • Among key measures is full enforcement of Title III of the Helms-Burton law of 1996 – ending waivers that three predecessor administrations had invoked – and allowing even Cuban-Americans who were not U.S. citizens at the time to sue companies involved in business dealings (“trafficking”) involving properties nationalized by the Cuban government since 1959. The U.S. officials have also pledged regulations clamping down on remittances to Cuba (which had already been regulated to ensure that senior government officials did not receive them); prohibiting dollar transactions through third-party financial institutions; and stopping “non-family” travel to the island. Details will not be known until the regulations are published, a process that usually takes several months.

The U.S. actions come at a delicate moment for the Cuban economy, will certainly worsen the country’s balance-of-payments situation by increasing the cost of international transactions, and will directly affect key sectors that depend on tourism and remittances.

  • Among the hardest hit will be Cubans engaged in private businesses, who depend on remittances for investment and foreign visitors as customers. At the end of 2018, a little more than 1.4 million formal jobs were in the non-state sector, including the self-employed (cuentapropistas), members of cooperatives, and private farmers – almost equal to the 1.6 million in state enterprises. Many others work in the informal sector to supplement their incomes.
  • The perceived increased risk posed by the U.S. measures will also cause foreign companies to postpone or cancel entirely plans to invest in Cuba.

Trump Administration efforts last year to reverse Obama-era policies, coupled with other challenges – including the weakening of the Venezuelan economy and the shift of a previously key partner like Brazil – are taking their toll on the Cuban economy. In addition, an accumulation of important internal problems has made the country vulnerable. Austerity measures announced as early as in summer 2016, including a reduction in imports and energy rationing in the public sector, have already hurt. Even in the context of a good international environment and improving ties with the United States, the Cuban economy grew slowly over the past decade. The ups and downs in policies dealing with the private sector, agriculture, and in the derailed process of reform in the dominant state sector – as well as setbacks in efforts to attract foreign investment – underscore the economy’s deep structural flaws and damage caused by deficient responses and successive delays.

In these changing times, appeals to “Resist!” are no longer enough. Aggravated by the U.S. measures, the expected worsening of the economic situation will disproportionately affect the most vulnerable of the Cuban people. The external problems could be the argument that the Cuban government needs to push aside obstacles to domestic economic reform. The country has immense internal potential but has been held hostage to the ideological purism that many profess.

  • The government of President Díaz-Canel has already announced new measures to stimulate the development of state enterprises, cooperatives, and the private sector itself. Foreign dependence has proven to be disastrous for Cuba. No foreign power is going to come to resolve the flaws of the Cuban model. Broadening and deepening reform, liberating the domestic productive powers, seems to be the only possible way forward in addition to rethinking international alliances and embracing markets more broadly.

April 23, 2019

*Ricardo Torres is a professor at the Centro de Estudios de la Economía Cubana at the University of Havana and a former CLALS Research Fellow.

Mexico: Gambling That Austerity Will Be Enough

By Juan Carlos Moreno-Brid*

Mexico City's Paseo de La Reforma

Mexico City’s Paseo de La Reforma / Flickr / Creative Commons

While continuing to emphasize his goal of reversing neoliberalism in Mexico, President Andrés Manuel López Obrador (AMLO) is pursuing a budgetary policy with austerity – not much-needed fiscal reform – as his top priority, at least for 2019-20. In his inauguration speech last December, AMLO repeated campaign themes deriding the neoliberal policies implemented in Mexico since the mid-1980s, blaming them, as well as rampant corruption, for the country’s slow growth, rising inequality, and widespread poverty. Since then, however, the President’s speeches on economic policy and his Secretary of Finance’s main policy documents have stated that all public-sector operations will be subject to strict austerity.

  • They have indicated that 1) there will be no fiscal reform in the first three years of the administration; 2) fiscal revenue will not increase this or next year as a proportion of GDP; and 3) in this period, the public sector will not incur additional debt. In other words, the implementation of AMLO’s proposed social and economic programs will depend on the availability of public revenues subject to the strict constraint of no additional resources through public borrowing or any tax reform. The government has made sharp cuts to government personnel and wages and eliminated various public entities, including ones created to attract foreign investment and tourism.

At the same time, AMLO plans to change the composition of public expenditures significantly to accommodate his top-priority projects, among them Jóvenes Construyendo el Futuro (a massive transfer of $180 per capita for an ambitious, and, in many ways, welcome apprentice program for up to 2.3 million youngsters); Sembrando Vida (planting a million trees); Adultos Mayores; and investment to put in place a Maya Train, building from scratch a new crude oil refinery in Dos Bocas, and revamping an airport in Santa Lucía.

More in line with AMLO’s stated intention of overturning neoliberalism, what Mexico really needs is a profound fiscal reform – strengthening public revenues, modernizing public investment strategies, and strengthening its development banks – to foster growth and equality with long-term debt sustainability and greater countercyclical capacity. It is a paradox that the new government chose to commit itself to a severely austere budget, reflected in cuts in public expenditures and an increased primary fiscal surplus.

  • The decision to refrain from tax reform, coupled with drastic austerity, imposes acute limits on the new administration’s ability to strengthen and modernize infrastructure, reduce income inequality through fiscal tools, or strengthen its capacity to act in a countercyclical way – not to mention alleviate major lags in the socioeconomic conditions of the poor population. The IMF, OECD, World Bank, ECLAC, the Centro de Investigación Económica y Presupuestaria (CIEP), Grupo Nuevo Curso de Desarrollo (UNAM), and many local think tanks have systematically underlined that Mexico’s tax revenues as a proportion of GDP are extremely low. According to the estimates of UNAM, CIEP, and others, those revenues are at least six percentage points short of what is needed to meet long-standing needs in infrastructure, health, pensions, education, and overall social security and protection concerns. By reducing the bureaucratic apparatus and public-sector wages virtually across the board, the administration runs the risk of further weakening the state’s technical capabilities in some key areas of public policy and thus undermining its ability to correct course.
  • The underlying reasons for the new government’s commitment to austerity seem to be more political than economic. It has stated that a significant amount of resources can be freed up by abating the rampant corruption, and it apparently believes that before implementing fiscal reform, the government must prove to the citizens that it can deliver efficiently, effectively, and with honesty. Whether there will be sufficient achievements in terms of economic growth and inclusion and in eliminating impunity to convince the middle and upper classes to accept a progressive fiscal reform three years from now is an open question, but the answer will determine Mexico’s economic growth path and progress in the reduction of inequality, poverty, and corruption, and perhaps too its social stability and the viability of its democracy in the future.

April 16, 2019

*Juan Carlos Moreno-Brid is a professor of economics at the Universidad Nacional Autónoma de México (UNAM).

Colombia’s Duque: The End of the Road for Empty Politics?

By a Colombia Watcher*

Iván Duque

Colombian President Iván Duque. / Casa de América / Flickr / Creative Commons

Colombian President Iván Duque’s first 100 days in office have left three important baskets empty: the basket of public policy, the basket of new ideas, and the basket of trust in government.  His problem is not so much that he is a puppet of his mentor, former President Álvaro Uribe; it is that they have failed to jettison their recent past and articulate a credible vision for Duque’s four-year term.

  • Duque’s economic development plan was hurriedly prepared with little policy guidance from the president’s office. It consists of a long list of sector-by-sector aspirations that bear no connection with either the current budget or realistic medium-term fiscal planning.  The underlying assumption appears to be that the government will somehow – on its own – abandon a longstanding tendency toward clientelism based upon contractual power for a results-driven technocracy.
  • Duque’s financial strategy appears to be stumbling. Congressional opponents say his nominee to be Finance Minister, Alberto Carrasquilla, is guilty of corruption in a previous job.  Instability in global prices torpedoed Duque’s plan to rely primarily on proceeds from a new oil boom, so the government has wagered on a highly unpopular and inequitable tax reform.  Reducing federal expenditures is out of the question — key constituencies depend on the government’s purchasing power – and a serious review of fiscal decentralization also appears beyond Duque’s political will and expertise.  Going back to debt financing would face legal, fiscal, and political challenges.
  • Achieving his promises to reduce corruption also appears difficult. The lack of accountability in the Odebrecht corruption case, in which supporters of Uribe (as well as former President Santos) reportedly were involved, has fueled cynicism.  Unlike in other Latin American countries, no high-level economic or political Colombian is in jail on Odebrecht corruption charges.  Moreover, leaks of irrefutable recordings and documents demonstrate efforts by the country’s attorney general, Néstor Humberto Martínez, to cover up irregularities.  (The auditor who leaked the evidence was subsequently killed, as was his son when he returned from Spain to attend the funeral.)

The new administration faces other challenges.  Polls taken immediately after the economic plan was announced showed that public support for the government continued its free fall after reaching the lowest level recorded during a president’s first 100 days in office.  The government appears to be looking for legal ways to abandon the already fragile peace process with the former FARC guerrillas – already undermined by the fact that killings and disappearances of local civic leaders continue unabated.  Dissident FARC members are returning to the jungle or joining the growing number of criminal bands that operate in both the cities and the countryside.  Protests joining students and workers from various sectors, including healthcare and transportation, continue to affect essential services in a way not seen in Colombia in recent years.

Restoring public trust in Colombian institutions will be a monumental task for which Duque does not appear to have a credible path forward.  He will probably struggle to distance himself from some of his scandal-plagued financial and political backers, but they will demand unconditional support and loyalty amid public outcry and pressure.  The coalition that ensured Duque’s second-round victory in June was temporary – united only to stop his leftist opponent – and is already showing signs of abandoning him.

  •  Duque may try to make international support a pillar of his presidency, as Uribe and Santos did, but even that is not going to be easy. He cannot expect the same enthusiastic endorsement Santos received from the European Union, Canada, or UN agencies, who applauded his focus on the peace process and building democracy from the bottom up.  There are already voices in the Duque government opposing efforts begun under Santos to meet the conditions for Colombia’s admission into the OECD club.  Duque may be optimistic of gaining U.S. support – heartened by the Trump administration’s reduced emphasis on human rights and democracy in the bilateral relationship – but the most Duque has gotten so far is some continuation of support for anti-drug efforts.  His desperate efforts to develop a strong direct relationship with President Trump have not yet borne fruit.

Duque appears burdened by the bonds that brought him to power – with members of his coalition, with former president Uribe, and with political and financial backers – that have either weakened or are now embroiled in scandal.  Delivering results and inspiring public trust and support may be beyond his skills, raising the prospect – still unlikely – that he might someday be tempted to resort to repressive tools.

November 29, 2018

* The author is a long-time Latin America specialist with particularly deep expertise on Colombia.

Ecuador: Lenín Moreno’s Balancing Act

By John Polga-Hecimovich*

Lenín Moreno

Ecuadorian President Lenín Moreno (far right) meets with members of the National Assembly in October 2018. / Diego Cevallos / Asamblea Nacional / Flickr / Creative Commons

As Ecuadorian President Lenín Moreno begins the post-honeymoon phase of his presidency, he appears firmly committed to positioning himself as a judicious voice and centrist in a region where ideological moderation and restrained oratory are the exception rather than the norm.  This might be unexpected given his political background and four years as vice president under leftist firebrand Rafael Correa (2007-17), but it makes sense given the country’s challenging economic situation and political constraints.  As previously noted, Moreno had two choices when taking office: remain loyal to his socialist roots, govern through his Alianza PAIS legislative bloc, and double down on Correa’s (fiscally unsustainable) “Citizens’ Revolution;” or move towards the political center, splinter his legislative majority, and abandon Correa and many of his policies.  He has decisively opted for the latter, attempting to navigate a middle ground between the left and the right.

  • No issue depicts the thin line Moreno walks more than Ecuador’s foreign policy, and no foreign policy issue reflects that tug-of-war better than his handling of Wikileaks founder Julian Assange. Assangeto whom Correa granted asylum in 2012 at the Ecuadorian Embassy in Londonis now a costly and increasingly undesirable houseguest.  He is a liability in Moreno’s quest for technical assistance, international loans, and greater security and commercial cooperation with the United States, which is still seeking justice for Wikileaks’s publication of U.S. classified material.  Although Moreno has called Assange “more than a nuisance” and “an inherited problem,” the president has been reluctant to push him out over concern for his human rights.  In July, Moreno suggested Ecuador was seeking guarantees that Assange would not face the death penalty.  Maintaining its delicate dance, however, in October, the government broke from its longstanding dialogue with British authorities over Assange’s situation and announced that it will no longer pay for his food and medical care.
  • Ecuador is also seeking closer relations with its right-of-center neighbors, beginning to distance itself from the region’s leftist governments, and attempting to rebuild ties with the United States. Since June, Moreno has attended the inauguration of Colombian President Iván Duque, met with Peruvian President Martín Vizcarra, welcomed U.S. Vice President Mike Pence to Quito, and launched a security agreement with Washington.  Moreno has also changed his tone with regards to Venezuela.  Speaking to the United Nations General Assembly on September 25, he spoke of the burden caused by arrival of more than 6,000 Venezuelan migrants a day and called for a national dialogue in that country, provoking an acrimonious back-and-forth between the two capitals that culminated in the Ecuadorian government tweeting that “corrupt, murderous, and lying socialism of the 21st century is still alive in Venezuela and producing the most massive migration in the country’s history.”

Moreno’s strategy to confront the country’s fiscal deficit, which was 5.5 percent of GDP in 2017, is an even greater departure from his predecessor’s approach.  Whereas Correa pursued financing primarily through oil-for-loan deals from China after Ecuador’s selective default in 2008, Moreno has turned to other global lenders such as the World Bank and Japan.  He has also pursued new commercial relationships and market-friendly policies, including a free trade agreement with the European Free Trade Association, beginning accession talks with the pro-market Pacific Alliance, and continuing to encourage foreign investment in Ecuador’s hydrocarbon industry.  However, Moreno has not fully committed to Washington consensus-style reforms: the government announced measures in August to reduce its $60 billion debt, but it also authorized over $1.2 billion in loans to the housing sector, agriculture, and small and medium-sized business to reactivate the domestic economy.

Although not an ideological rightist like Chilean President Sebastián Piñera or Colombian President Iván Duque, Lenín Moreno has reoriented many of Rafael Correa’s domestic and foreign policies out of necessity as he confronts Ecuador’s difficult economic situation.  Given that the country’s fiscal deficit and outstanding debt are strategic challenges, it seems likely that he will continue to judiciously tread this middle path.  Although fiscal austerity measures have lowered Moreno’s approval rating and provoked protests from the Correista left, it would be a mistake to bet against him.  Moreno has not only upended expectations but also proven far more resourceful and politically sophisticated than his critics—and probably even his admirers—expected.  He may also send Julian Assange at some point an eviction notice.

November 6, 2018

*John Polga-Hecimovich is an Assistant Professor of Political Science at the U.S. Naval Academy.  The views expressed here are solely those of the author and do not represent the views of or endorsement by the Naval Academy, the Department of the Navy, the Department of Defense, or the U.S. government.

Argentina: From Gradualism to Shock Therapy

By Arturo C. Porzecanski*

Argentine President Mauricio Macri

Argentine President Mauricio Macri. / Wikimedia / Creative Commons

The austerity measures that President Mauricio Macri announced yesterday to deal with the sharp depreciation of the Argentine peso and acceleration of inflation in the past couple of months are a belated but entirely appropriate effort to stem the country’s massive capital flight.  His administration intends to lower government spending and reimpose taxes on exports to reduce the fiscal deficit faster than envisioned in May, when a three-year economic program was agreed with the International Monetary Fund (IMF).  This is in addition to a previously announced government hiring freeze and cuts to subsidies for electricity and other services.

  • Specifically, the goal now is to minimize the public sector’s financing requirement for 2019, limiting it to rolling over debt maturities coming due plus borrowing $15 billion mostly from the IMF, World Bank, and Latin America’s development banks (CAF and IADB), to cover the interest payments coming due next year. All told, the fiscal deficit contraction that would be achieved between 2017 and 2019 is equivalent to about four percentage points of GDP, compared to the previously pledged 2¾ percent of GDP in savings embodied in the IMF program.
  • In return, Macri’s government has requested the IMF to speed up disbursements under the $50 billion loan facility, which had envisioned a $15 billion up-front payment in June, made on schedule, plus installments of about $3 billion per quarter through June 2021, depending on performance and need. The Fund’s Managing Director, Christine Lagarde, has instructed IMF staff to work with the Argentines to reach a rapid conclusion of discussions to present to the Executive Board for approval.

Macri’s announcement was an admission that what had been advertised in May as a strictly “precautionary” loan must now be amended to provide emergency financing full-throttle.  While a number of emerging-market currencies have come under downward pressure in recent months, the sell-off in Argentina is only comparable to that in Turkey: both the Argentine peso and the Turkish lira currently buy about half as many U.S. dollars as they did at the start of the year (now 100 pesos = $2.60 vs. $5.40 then).  The currency downdraft has dragged Argentine stocks and bonds down when measured in dollar terms; the probability of a debt default in Argentina, as deduced from bond yields, currently ranks highest of all in the emerging markets but for Venezuela, in default since late 2017.

  • Last December, the central bank of Argentina (BCRA) committed itself to achieving an inflation rate of 15 percent during 2018, but prices rose more than that just in the first six months of the year. Given the cost-push pressures unleashed by the peso’s sharp depreciation since May, Argentina would be lucky to end the year with inflation cumulating less than 40 percent.  The patent failure of monetary policy to stabilize the currency and curb inflation thus far will probably be hotly discussed during the government’s negotiations with the IMF.  Last week the BCRA hiked its target interest rate to 60 percent from 40 percent in early August, which is more than double the level that prevailed through May.  Chances are that the IMF will pressure the central bank to keep interest rates significantly above expected inflation until the fever breaks.

We wrote in mid-May that we were witnessing in Argentina the demise of President Macri’s cherished – and popular – gradualism in tackling the poisoned inheritance left after 12 years of populism under presidents Néstor and Cristina Kirchner.  Now we are beholding the embrace of “shock therapy” in fiscal and monetary policies by the Macri administration.

  • Macri and his economic team keep blaming adverse circumstances, such as the worst drought in 30 years, which has delivered the poorest harvest since 2009; risk aversion among investors because of the tightening of U.S. monetary policy; and uncertainty generated by the “corruption copybooks” scandal involving Kirchner government officials and construction industry businesspersons. Their diagnosis is patently wrong.  Despite the poor harvest, Argentine export earnings through July have increased in the best performance in several years.  The tightening of U.S. monetary policy has been very gradual and well telegraphed in advance; it has not caused problems in prudently managed countries.  And the recent scandal is tarnishing Macri’s opposition in the legislature and has not reached the scope of the “carwash” scandal in Brazil.
  • Macri and his team are reaping what they sowed. In 2016-17 they claimed that they could do little to address the inherited fiscal and monetary problems because otherwise they would lose precious seats in midterm congressional elections and end up as lame ducks.  And then, after Macri’s party Cambiemos did well in the October 2017 contest, they claimed that in 2018-19 they could do little to address the inherited fiscal and monetary problems because otherwise they would lose the presidential elections in October of next year.  Up until February, local and foreign investors were willing to give the Macri administration the benefit of the doubt, but then they got impatient, started to pare their positions especially in short-term government bonds, and subsequently decided to exit on a large scale when the central bank failed to tighten monetary conditions sufficiently to keep the peso from depreciating rapidly.

September 4, 2018

*Dr. Arturo C. Porzecanski is Distinguished Economist in Residence at American University and a member of the faculty of the International Economic Relations Program at its School of International Service.

Argentina: The Downside of Gradualism

By Arturo C.  Porzecanski*

Tortoise heads down a dirt path surrounded by greenery

Towards Turtle Path / Maxpixel / Creative Commons

President Mauricio Macri made a surprise announcement on May 8 that his government would seek financial support from the IMF to enable the country to “avoid a crisis like the ones we have faced before in our history” – essentially, an admission that time may be up for his policy of gradualism in dealing with the legacy of populism.  Sources in his administration expressed confidence that Argentina could obtain some $30 billion in “precautionary” loans at low interest rates and with few strings attached as an alternative to more borrowing in the international capital markets at higher and rising rates.  His finance minister, Nicolás Dujovne, and other members of the economic team departed Buenos Aires for Washington, DC, that same evening to formalize the request at IMF headquarters and to meet with a top Trump administration official at the U.S. Treasury.  After an initial round of friendly conversations, the parties agreed to meet again starting on May 14 to initiate a negotiation process that they acknowledged would take several weeks.

  • Macri blamed downward pressure on the Argentine peso (despite drastic hikes in short-term interest rates and the sale of one-tenth of hard-currency official reserves), on tighter monetary conditions and on volatility abroad at a time when the government must still raise money internationally to finance its large fiscal deficit.  “The problem that we have today is that we are one of the countries in the world that most depends on external finance, as a result of the enormous public spending that we inherited and are restoring order to,” the President stated.
  • The decision to turn to the IMF surprised observers because it came at an unusually early point in the country’s financial cycle.  Argentina’s central bank still has about $55 billion in international reserves, the equivalent of some 10 months of imports, or three times the amount of foreign-currency government debt maturing in 2018.  Also, foreign investors by no means have slammed the door on Argentina’s face, though admittedly the government probably could not sell another 100-year dollar bond like it did last June, raising $2.75 billion from die-hard optimists.  Argentina in the past, like most other countries, has generally turned to the IMF only in desperation once they were unwelcomed by Wall Street and their vaults were almost bare.
  • The onus placed by Macri on deteriorating financial conditions abroad was also surprising.  After all, the U.S. Federal Reserve has barely begun its monetary tightening process: the overnight fed funds rate, currently around 1.7 percent per annum, is still below U.S. inflation of 2.1 percent, so it has yet to enter positive territory.  Moreover, U.S. bond yields now in the vicinity of 3 percent for 10-year Treasuries, are up from 2.3 percent a year ago but have merely bounced back to a level they were at as of end-2013.  And the financial markets’ “fear” index VIX, a measure of expectations implied by options on the S&P 500 index, has fluctuated in the teens, which while higher than last year’s mostly single digits, remains very far from the range of 30 to 80 seen during prior episodes of extreme risk aversion in the financial markets.

 President Macri’s announcement did not have the favorable intended effect on confidence and market behavior, as evidenced by the peso remaining under downward pressure in the three business days that followed.  Despite renewed central bank intervention to boost the currency, it now takes almost 24 pesos to buy a U.S. dollar when it took fewer than 16 pesos to do so a year ago – a loss of about one-third in the currency’s purchasing power.  One reason is that Macri’s blaming adverse developments abroad for his currency’s woes rings hollow with investors, given how very slowly his administration has moved to reduce a fiscal deficit running above 6 percent of GDP since 2015; how much debt (around $100 billion) he has taken on in just a couple of years; and how timid his central bank has been in its attempt to bring down inflation running at about 2 percent per month.  And the other reason is that it quickly became apparent that any loan from the IMF will come with strict conditionality attached, because Argentina’s request was routed to the Fund’s regular, “stand-by” window – and not to its easier-access, precautionary lending window for highly creditworthy borrowers.  The Fund spelled out its economic policy advice for Argentina in its December 2017 “Staff Report for the 2017 Article IV Consultation,” and it calls for a more assertive reduction in the fiscal deficit, especially by cutting government spending, and for supply-side reforms it called “indispensable” to support economic growth, raise labor productivity, attract private investment, and enhance the country’s competitiveness.  These are all recommendations that fly in the face of President Macri’s gradualist approach to defusing the economic minefield left behind by his populist predecessor, Cristina Fernández Kirchner, and will therefore paint his government into a politically fragile corner.  We are witnessing the demise of Macri’s cherished – and popular – gradualism.

 May 14, 2018

*Dr.  Arturo C.  Porzecanski is Distinguished Economist in Residence at American University and Director of the International Economic Relations Program at its School of International Service.

 

Brazil in 1999: The Impact of Rigid Labor Regulations

By Jennifer P. Poole and Rita Almeida*

The outside of a building in Brasilia, Brazil

Brazil’s Ministry of Labor and Employment in Brasília. / Grupo Vestcon / Creative Commons

During Brazil’s currency crisis and devaluation in 1999, stringent implementation of labor regulations hindered, rather than enhanced, manufacturing plants’ recovery and workers’ wellbeing – an important lesson to keep in mind in current debates in many countries.  In an article published in the May 2017 Journal of Development Economics (JDE), we examine the implications of global economic integration through international trade on local labor markets during that critical period in 1999.

  • Many economic policymakers agree that reforms in the latter half of the 20th century, such as liberalizing trade relations and encouraging foreign investment, have been powerful drivers of efficiency gains, income growth, and consumer choice around the globe. At the same time, however, there is agreement that – as firms adapt to a more competitive global environment – the gains are often accompanied by short-term costs for workers in terms of unemployment and income risk.  Policymakers have to weigh the broad economic benefits from globalization and technological change, on the one hand, against workers’ opportunities and security on the other.

A micro-econometric estimation analysis of detailed, confidential, and proprietary micro-data sets – collected in part while visiting the Brazilian Labor Ministry – reveals a causal impact of trade reform on employment.  Brazil’s policy environment of strict labor market regulations (e.g., hiring and firing costs), coupled with its dramatic trade liberalization and currency devaluation, make it a particularly appropriate setting to study the implications of globalization on employment opportunities in a middle-income country.  As in many countries, much of the de jure labor market framework was established on a national basis in Brazil (in the Brazilian Federal Constitution of 1988), but de facto labor regulations – the varying levels of implementation through labor inspections, fines, and other processes in different locales – are heterogeneous.

  • Administrative data on the enforcement of labor regulations during the 1999 currency crisis, a shock to trade openness, show that the way trade affects employment largely depends on the stringency of de facto labor regulations that companies face. The impact of the currency devaluation – widely predicted to expand employment by facilitating access to foreign markets and weakening import competition – was less significant in plants facing strong labor enforcement than in those facing more lax enforcement.  The findings suggest that stringent labor regulations limit job creation and lower productivity gains.
  • Not only was the efficient reallocation of labor in response to shocks inhibited by strict de facto labor market regulations; rigid enforcement also restricted the within-plant potential for productivity gains. The data reveal that regulations, for example, may limit plants’ ability to introduce new goods or investment in more complex production technologies that might have higher value-added.  The burden of having to retain unproductive workers, making plants less able to compete, is another possible explanation for weak productivity gains.

Previous research – arguing that weak enforcement leaves regulations ineffective – ruled out the possibility of labor regulations as an explanation for slow labor adjustment to trade reform.  But our research shows that flexible regulations maximize the gains of reforms such as trade liberalization.  As middle-income countries continue to face a globalizing and technologically advancing world economy, their strict labor market policies, limiting adjustment and reallocation, may have potentially distortive, unintended consequences.  The trade-off between job security, on the one hand, and productivity and growth is already one of the most prominent public policy debates worldwide.  Regulations designed to protect workers may actually further reduce employment as costs increase.  Countries must show flexibility, while enhancing education and training programs, to benefit fully from changes driven by the global economy.  As populist, protectionist policies gain influence in the world, policymakers should know that increasing the flexibility of de jure regulations will allow for increased job creation and thus offer broader access to productivity gains.

March 7, 2018

*Jennifer Poole is Assistant Professor of Economics, School of International Service, and Research Fellow at the IZA Institute of Labor Economics and the CESifo Research Network.  Rita Almeida is a Research Fellow at the World Bank and the IZA Institute of Labor Economics.  Their article is titled “Trade and Labor Reallocation with Heterogeneous Enforcement of Labor Regulations.”