Financial and Monetary Systems

Why it's time for intelligent austerity in Latin America

Helicopters belonging to the media fly over Paulista Avenue where people are protesting against Brazil's President Dilma Rousseff, as part of nationwide demonstrations calling for her impeachment, in Sao Paulo, Brazil, March 13, 2016.

Image: REUTERS/Paulo Whitaker

Ernesto Talvi
Director, Brookings Global-CERES Economic and Social Policy in the Latin America Initiative
Share:
Our Impact
What's the World Economic Forum doing to accelerate action on Financial and Monetary Systems?
The Big Picture
Explore and monitor how Latin America is affecting economies, industries and global issues
A hand holding a looking glass by a lake
Crowdsource Innovation
Get involved with our crowdsourced digital platform to deliver impact at scale
Stay up to date:

Latin America

Supersonic growth rates in China and sky high commodity prices have come to an abrupt end. The end of the Fed's quantitative easing and zero interest rate policy and balance sheet exposure to the appreciation of the U.S. dollar, have led to a reassessment of risk in emerging markets and a sharp slowdown in capital inflows.

Latin America was hit the hardest. Growth rates took a dive and the gut reaction of serious governments across the region to this abrupt slowdown has been the introduction of austerity measures to contain public spending and raise revenues. They come precisely at a time when regional economies are cooling off sharply, and when the socio-political landscape is turning dangerously toxic as corruption scandals and frustrated expectations of a brighter future after a decade of exuberant growth fuel social discontent.

Reacting with the mindset of the 1980s and 1990s is the wrong approach for national economies in Latin America and other emerging markets, and for the global system. In a world of excess saving (if you believe former Fed Chairman Ben Bernanke’s saving glut hypothesis), dearth of investment (if you believe former Treasury Secretary Lawrence Summers’ secular stagnation hypothesis) and rock bottom interest rates, the whole concept of austerity should be revisited.

What we need is a paradigm shift towards intelligent austerity. Take for instance Latin America. It is a region with a huge infrastructure deficit that hampers connectivity to regional and global markets. The quality of education is dismal. According to the Program for International Student Assessment (PISA) administered by the OECD, 60% of the region’s 15 year-olds do not have the minimum skills to enter productively into formal labour markets and the knowledge economy. Informality is running wild. For the typical Latin American country, 70% of the labour force is employed by the informal sector, leading to a miniaturization of the economy with a disproportionately large share of output being generated by very small and unproductive firms.

Public expenditure or tax policies that take advantage of very low real world interest rates to promote productivity-enhancing investments in infrastructure and human capital, or as professor Ricardo Hausmann of Harvard University has recently suggested, in housing, urban transport and social services to connect informal workers to the complex urban networks where modern production takes place, should be pursued.

The international community should play a key role in ensuring that they are. Development banks should go back to basics and use their ability to tap cheap resources in global markets and channel those resources to emerging markets, while at the same time making sure that those resources are channeled to socially productive investments. The IMF should ensure that resources are only channeled to countries with a coherent macroeconomic framework. Moreover, it should also ensure that socially productive investments are not computed as regular deficits or debt. In economic terms they are not. Rating agencies and markets will thus be reassured that cheap and abundant resources are being used intelligently, and only by eligible countries on eligible projects.

So far the debate of how much austerity is too much has been confined to the developed countries that pay Lilliputian interest rates, such as the U.S., Germany and Great Britain. But this debate should be extended worldwide to encompass emerging economies. After all, it is in the emerging world where many if not most of the socially profitable investment opportunities surely lie. If the global financial system is not performing the task of allocating excess financial and capital resources to emerging economies and forcing upon them excessive austerity, international financial institutions should step in to fill the void. Directly, or by levering up public-private partnerships and private sector investment.

Very low real interest rates should not be a license to spend irresponsibly. Even at zero interest rates countries still have to pay back principal. However, the support of the international community for intelligent austerity in emerging markets that combines a credible macroeconomic framework with responsible public spending, would spread the benefits of very low interest rates worldwide and help rekindle global growth.

This blog is part of a series of articles published ahead of the World Economic Forum on Latin America 2016, taking place from 16 to 17 June in Medellin, Colombia.

Don't miss any update on this topic

Create a free account and access your personalized content collection with our latest publications and analyses.

Sign up for free

License and Republishing

World Economic Forum articles may be republished in accordance with the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International Public License, and in accordance with our Terms of Use.

The views expressed in this article are those of the author alone and not the World Economic Forum.

Related topics:
Financial and Monetary SystemsEconomic Growth
Share:
World Economic Forum logo
Global Agenda

The Agenda Weekly

A weekly update of the most important issues driving the global agenda

Subscribe today

You can unsubscribe at any time using the link in our emails. For more details, review our privacy policy.

The ZiG: Zimbabwe rolls out world’s newest currency. Here’s what to know

Spencer Feingold

May 17, 2024

About Us

Events

Media

Partners & Members

  • Join Us

Language Editions

Privacy Policy & Terms of Service

© 2024 World Economic Forum