Development Bank Research Bulletin

Rafael Correa: another Latin American president with an econ Ph.D.

Rafael Correa has been favored to become the next president of Ecuador, in the upcoming election, probably after a second-round run-off (See the Latin Americanist Blog for a brief). He is very likely to become another Latin American president with a Ph.D. degree in economics (e.g. Ernesto Zedillo, Mexican president 1994-2000, Ph.D. Yale '81)

He has been rumored to be a leftist and a close friend of Hugo Chavez. Nevertheless, as a U.S.-trained economist with a Ph.D degree in economics from the University of Illinois ('01), and a previous degree from Belgium, it is a neccesory strategy for him to campaign under an ultra-leftist and anti-West platform, otherwise other candidates from the far-left can easy attack him and alienate him based on his U.S. education background.

His former professor, Werner Baer, who is a Latin American expert, knows the trick very well: "My guess is that some of the posture he's taking now is because that's the way he hopes to get elected and win votes. Once in power, I doubt that he would be virulently anti-American like Chavez." He said Correa would more likely follow the lead of President Luiz Inacio Lula da Silva of Brazil, who spooked investors with radical discourse as candidate, but once in office "became extremely orthodox in his economic policy."

In April 2005, Correa was appointed economy minister, but he was forced to resign after four months when he failed to consult the president before publicly lambasting the World Bank for denying Ecuador a $100 million loan. He now portrays himself as a “Christian leftist”, and concurs with Chavez’s attack of Bush by adding that "to call Mr. Bush the devil is an insult to the devil" and that “The devil is evil, but intelligent.”

This cheap talk is all understandable and predictable. Do you know of any other easier strategy that can help you accumulate political capital so fast in Latin America?

His professor Baer described Correa as a top-notch economist, which I would not agree.
At least his doctoral dissertation did not appear to confirm it. According to a self-description Correa made when he was still a Ph.D. student in University of Illinois (UIUC), his research was mediocre:

“My dissertation and research interests are Economic Development and International Economics. Specifically, the first part of my dissertation evaluates the effects of liberalization and globalization on the Latin-American economic growth, investment, and productivity. I am using state of the art techniques in instrumental variables and dynamic panel data models. The panel includes 19 Latin-American countries. The second part of the dissertation studies the economic desirability of a monetary union for the Andean countries. In this study, the basic techniques are vector auto-regressive models and disturbances orthogonalization. The third part of the dissertation is an evaluation of the impact of structural reforms on growth, human development and poverty in Latin America.”

However, he is certainly not a leftist! He is simply a political opportunist. We will see.

Financial Times interviews Lula and Alckmin

Financial Times' Richard Lapper and Jonathan Wheatley has made two long interviews with two leading candidates in the upcoming Brazilian presidential election.

Both Lula and Alackmin are the type of politicians who really try to convincing people by making points rather than by making sensational appeals, which is a bless for Brazilian politics. Indeed, from the long-term historic perspetive, Brazil is probably the most peaceful (baring the everyday petty street crims and the recent Sao Paolo riot) nation in the World. Immigrants from different origins, of different skin colors live quite comfortably along each other (relative to other immigrant nations), and even the military coups turned out to be the least bloody than they usually should be.

Let's see what they have to say to all of us, on the future of Brazil, and how they plan to make it a better one:

Interview transcript: Geraldo Alckmin (Centrist)
Interview transcript: Luiz Inacio Lula da Silva (Left)

My general impression is that,   the two's policies are not fundamentally different (partly because Lula is not that type of radical left, and partly because Alckmin really doesn't have anything new and concrete to impress and convince voters), and Alckmin's inexperience is going to cost him dearly.  Alckmin is much less eloquent and charismatic than Lula, and I don't see hard evidence that Alckmin can really get things done despite his repeated claim that "we have a lot of experiences" in this and in that.

I would bet that Lula is going to be re-elected by large margin.

Deutsche Bank’s take of China, India, Brazil and Mexico: Reports

Below I put together a collection of country research reports produced by Deutsche Bank Research, on several important emerging economies. Let's see what are Deutsche Bank's take of Goldman Sachs's BRICs.

China 2020: challenges ahead (PDF file)
China should be able to achieve high growth for another decade, moving its GDP above that of most industrial countries. Challenges however include a fragile banking sector, rising unemployment, large government debt, and corruption within the one-party political system.

India rising: a medium-term perspective (PDF file)
GDP per capita will double in 2020. Favorable demographics, increasing investment in education and infrastructure and further integration with the world economy are the factors behind DB’s projections. IT-related services, textiles, and the auto-ancillary industry and pharmaceuticals are expected to gain dynamism given India’s comparative advantage.

Brazil: O pais do futuro? (PDF file)
Grow at an average of 3.3% year. Competing against China, Brazil is likely to maintain its position in niche high-tech sectors where it has a competitive advantage. Increased Chinese demand for commodities will provide Brazil with an opportunity to move up the value chain in commodity-related sectors.

Mexico 2020: Tequila sunrise (PDF file)
Geographic closeness to the US gives it an unique advantage. There is fair chance that Mexico’s industrial profile will make a successful transition from low value-added to more sophisticated products.

Latin America vs China: a more meaningful topic than India vs China

Many people are tired of the India vs. China debate. After all, India and China are more likely to be complementary than substitute for each other. One is better in hardware while the other is better in software, there is more opportunities for cooperation.

There absolute loser from China’s rise in world production is actually Latin America. Latin America has much higher wage level than China, Thailand, or Malaysia. The region however is much backward in production technology. This is not going to be sustainable. In a “flattened world”, no importers are willing to pay higher price for lower quality products.

Jeffery Sachs used to say: the problem of Argentina is not fiscal policy, but how it is possible that a country like Argentina, with per capita income as high as 10,000 USD, is still engaging in low knowledge-intensive productions.

It is not sustainable. You need to overhaul your education system and upgrade your production technology, in order to catch up with the rising East Asia.

The Inter-American Development Bank has just published a book on this very topic, titled  “The Emergence of China: Opportunities and Challenges for Latin America and the Caribbean”

The book is available for download (PDF file)

As food for thought, the book provides very detailed background information and insights. I am not happy with the answer of the book though, that the solution for Latin America is to serve China as a provider of energy, raw material, and commodities. You are turning Latin America into Africa (Nigeria, specifically)!

Brazil in the short term has reason to celebrate as it hits a jackpot as a result of China's hiking demand for iron ores, but don't forget that India is actually a bigger exporter of iron ores to China than Brazil currently is. If India can be an exporter of both raw material and high-tech services, why do you think Latin America should accept to be downgraded to a misery third-world exporters of commodity producer.

Hope this article can stimulate some discussions on how Latin America can cope with the rise of China and East Asia.

Richard Nixon used to advise then young Donald Rumsfeld : “Latin America does not matter.... no one gives one damn about Latin America!” Hope that’s not an accurate description of the reality.

What do surveys tell us on how to win Latin America’s soul?

As the Economist magazine features in “The battle for Latin America's soul”, Latin American countries one by one is falling into hands of populists who oppose to economic reforms. It thus becomes an urgent question how market economy and economic reform can win Latin America’s soul again?

Ugo Panizza and Monica Yanez from the Inter-American Development Bank recently published a paper titled “Why are Latin Americans so unhappy about reforms?” in which they looked into the  Latinobarometro survey, which was conducted yearly in Latin American countries since 1996, for answers.

They use the opinion surveys to document discontent with the pro-market reforms. They explore  four possible sets of explanations for this discontent: (i) a general drift of the populace’s political views to the left; (ii) an increase in political activism by those who oppose reforms; (iii) a decline in the people’s trust of political actors; and (iv) the economic crisis.

What they find  is that the macroeconomic situation plays an important role in explaining the dissatisfaction with the reform process, while the other factors are not important. 

Detailed research of the survey data show that even if in 1997 100% of people belong to the center right, while in 2002 100% of them convert to extremist left, the support for reform will only go down by 9%. This means that even such an extreme assumption of drift to the left can only explain one third of the actual drop in support for reforms.

The survey results also show that increasing political activism of the leftists or decline in the trust of political actors cannot explain the drop in support for reforms

The single most important factor is the economy. Drop of GDP growth by one percentage point can reduce support for reforms by 1.1%. In the case of Argentina, growth rate dropped by 21 percentage points  between 1997 and 2002, which would predict a drop in support for privatization equivalent  to 23 percentage point.

In Latin America, countries experiencing crisis usually fall into vicious cycle.  When the economy performs badly or experiences a crisis, it becomes much easier for populists to get into power and halt economic reforms. Without reforms the country cannot gain real competiveness internationally, and the political situation becomes self-reinforcing as the economy deteriorate further (sometimes several years can be saved with high oil price, but then the pain will be felt harder when oil price drops).

Economic and employment growth is the only criteria voters use to evaluate reforms, and they usually don’t give you second chance. Reformists need to think more about the stability consequence of the reforms they propose, because “one strike, you are out”. Better do it slowly but safely.

Reference:

Why are Latin Americans unhappy about reforms?

Carlos Slim, a shadow Mexican presidential candidate

International Herald Tribune carries a story about “one of the world's richest men turns to Mexico's future”.

Pro-business policy is indeed good for Mexico, but there is reason why business tycoon shouldn’t participate directly in politics.

“Slim, who has amassed a $30 billion fortune building Latin America's biggest telecommunications empire, has stepped aside from running companies to try to set the economic and social agenda for Mexico. Although he is not running in the July 2 presidential election, Slim has been acting like a candidate. He has been traveling the country by private jet in a campaign to convince the next government to cut energy costs, rid the legal system of corruption and allow more private investment in roads, power plants and the state oil monopoly, Petróleos Mexicanos, or Pemex.
....
Slim's 11-page proposal, called the Chapultepec Accord, after the Mexico City park where it was announced, includes making the police and courts more independent, cutting red tape to make government programs more responsive to the poor, and allowing more private investment in housing, schools, clinics, roads and bridges.

"The only healthy way to invest is if it's a combination of public and private investment," he said.

Slim is preparing to profit if his proposals go forward. In September, Slim created a company called Impulsora del Desarrollo & el Empleo en America Latina, or Ideal, to build roads, waterworks and power plants if Mexico's next president follows his recommendations for more private investment.

Absent in Slim's campaign is a call to force more competition in telecommunications. His flagship company, Teléfonos de México, or Telmex, controls more than 90 percent of the fixed phone lines in Mexico. In the past eight years, Telmex has used the courts to block antitrust rulings designed to reduce its dominance."

How could one of the most successful bank regulatory systems fail so easily? The case of 2001 Argentina

Found an old working paper written by Charles Calomiris (Professor in Columbia University) and Andrew Powell (then Chief Economsit of Central Bank of Argentina) back in 2000, in which they portrayed Argentine banking regulatory system as one of the two or three most successful in emerging economies and a role model for every one to follow.

Browsing through the paper, I am deeply impressed by the quality of Argentine system at that time. The Central bank even had an online database of debtors (I don’t know whether they still supply this service) where general public can enter a company name and know the name of the bank extending the credit, the amount of the credit, the quality category of the loan, and the details of any guarantees extended. Bank depositors, shareholders, and researchers thus were able to monitor banks’ credit exposure at real time. Absolute disclosure as a tool for market discipline! This is what any economists would theoretically advise and seldom expect to be realized in the real world. The Central Bank of Argentina however managed to make it happen. If I read this paper in 2000, I would have invested all my money in these wonderful Argentine banks.

Within a year, however, as everyone has known, Argentine banking system failed. Not the bankers' fault; not the bank regulator's fault. The government screwed up in macro policies and brought down the banking system -- something that Calomiris and Powell thought wouldn't happen, not again!

Several lessons for observers:
(1) It is always more risky to praise a country than criticize it. When you criticize a country, you can never be falsified because you can always argue that the arrival of crisis is just a matter of time. When you praise a county, however, the natural law of mean-reversion will always prove you wrong. Things can only get worse.
(2) As a banker, however smart, honest and hard-working you are, the state is always trying to screw you up by some irresponsible fiscal and exchange rate polices. Don’t under-estimate the evilness of government. In the wake of every crisis, Argentines think: “the government won’t do it (freeze the deposit)  again.”. The government won’t change.
(3) When everything looks so wonderful, something must be wrong! If you cannot find it after doing extensive research, something very big must be wrong.

Can Emerging Market Bank Regulators Establish Credible Discipline? The Case of Argentina, 1992-1999 By Charles W. Calomiris, Andrew Powell
Abstract: In the early 1990s, after decades of high inflation and financial repression, Argentina embarked on a course of macroeconomic and bank regulatory reform. Bank regulatory policy promoted privatization, financial liberalization, and free entry, limited safety net support, and established a novel mix of regulatory and market discipline to ensure stable growth of the banking system during the liberalization process. Argentina suffered some fallout from the Mexican tequila crisis of 1995, but its response to that crisis (allowing weak banks to close) and the redoubling of regulatory efforts to promote market discipline after the crisis made Argentina’s banking system quite resilient during the Asian, Russian, and Brazilian crises. Argentina’s bank regulatory system now is widely regarded as one of the two or three most successful among emerging market economies. This paper traces the evolution of the regulatory policy changes of the 1990s and shows that the reliance on market discipline has played an important role in prudential regulation by encouraging proper risk management by banks. There is substantial heterogeneity among banks in the interest rates they pay for debt and the rate of growth of their deposits, and that heterogeneity is traceable to fundamental attributes of banks that affect the riskiness of deposits (i.e. asset risk and leverage). Moreover, market perceptions of default risk are mean-reverting, indicating that market discipline encourages banks to respond to increases in default risk by limiting asset risk or lowering leverage.

What do Brazilian firms get for contributing money to politicians? More money.

Businessmen are not running charity organizations; They are pragmatic and calculating;  They wont’ give you money for free. For every dollar they give you, they will at least recover the costs. Last time I covered an academic paper about Thai elections, which shows that businessmen-cum-politicians reap huge benefits after they get into power. This is true for Brazil too. Let me show you a recent study.

Stijn Claessens and  Luc Laeven (World Bank) and Erik Feijen (University of Amsterdam) examine political campaign finance in 1998 Brazilian elections and find that elected politicians might  be  able to feed back to their financial supporters by directing more banks credits (presumably from state-owned banks) to them.

Every investor in Brazil (I would say it is more the case in Italy where everything is about politics) understand such game; As a matter of fact, we find that stock prices of those listed firms that contributed to politicians rose sharply over  election days.

A further question I would like to ask is: if the rule of the “game” is so clear, why do some firms contribute while the others do not?  Well, certainly I don’t believe that those who don’t contribute are cleaner in their conducts. But why don’t they contribute?

In many developing countries, those who contribute to politicians are actually the least connected. Politicians in Brazil routinely request kick-backs or "monthly-payment" from the business community. A tape revealed that Waldomiro Diniz (an advisor to the Minister Jose Dirceu) was extorting the gambling mafia of Rio de Janeiro to gain funds for Worker's Party political campaigns. These mafias are just underdogs. Those who are truely connected sit on corporate boards.

Those tycoons who really hold de facto power don’t give a shit to these politicians: In January 2002, Celso Daniel, who had already been appointed coordinator of Lula's campaign for the October elections was murdered. Unless there emerges a strongman military dictator, it is more likely that the tail (business tycoons) will wag the dog (politicians)!

Does Campaign Finance Imply Political Favors? The Case of the 1998 Brazilian Elections

Abstract: This paper provides empirical evidence that campaign contributions are strongly associated with market expectations of future firm-specific political favors, including preferential access to external financing. Using a novel dataset, we find that firms in Brazil providing contributions in the 1998 campaign to (elected) federal deputies experienced higher stock returns following the election, even after controlling for industry-specific effects. This suggests that federal deputies were expected to shape policy to benefit these firms in particular. Consistent with such political favors, we find that these firms relative to a control group substantially increased their financial leverage in the four years following election, suggesting that contributions gained firms preferential access to finance.

For a review on campaign finance's role in Brazilian politics, please read Professor David Samuels' article: Money, elections, and democracy in Brazil