Hoover Daily Report

When Globalization Isn't Enough

Monday, April 12, 2004

Over the past several years a debate has taken place between the political leaderships of the United States and Latin America over globalization. Beginning in the late 1980s most Latin American countries opened their economies to foreign trade and investment. The expectation was that this dramatic change from past policies would ignite rapid growth and cure the region's endemic poverty. The results did not match expectations. With the exception of Chile, Latin American GDP growth has been, at best, sluggish. During the 1990s real GDP per worker in Mexico and Brazil increased by only 1 percent a year, while GDP per worker in Argentina and Venezuela actually declined in real terms.

The prescription of the Bush administration for this problem, articulated at the Summit of the Americas in Monterrey, Mexico, this past January, is that Latin America needs to be even more integrated into the global economy. The U.S. government has therefore been pushing the adoption of a Free Trade Area of the Americas (FTAA). Many Latin American political elites, looking back at the experience of the 1990s, have cast strong doubts on this suggestion. Indeed, Brazilian president Luiz Inacio Lula da Silva has openly argued against the proposal, and Argentine president Nestor Kirchner and Venezuelan president Hugo Chavez have been critical not only of an FTAA but of global economic integration broadly defined.

In the ensuing debate over globalization, both sides in the debate have missed a crucial point: openness to trade and investment is important but is not in itself a panacea. Foreign direct investment (FDI) and openness to foreign trade help those sectors that produce tradable goods, such as automobiles, but have very little effect on sectors that produce nontradables, such as education. Moreover, the nontradable sector produces inputs for the tradable sector, meaning that, in the absence of policies that will increase the efficiency of the nontradable sector, the effects of FDI and foreign trade will be blunted.

Increasing the efficiency and competitiveness of the nontradable sector cannot be accomplished by increasing or decreasing the degree to which an economy is globalized. Such efficiency and competitiveness require domestic reforms that increase the effectiveness of domestic firms and markets.

Among the most crucial reforms are those related to Latin America's domestic financial systems, most of which are inadequate. Those industries producing nontradable goods need access to financial markets and banks in order to expand. So too do Latin American households, which need to finance investments in education, home ownership, and durable consumer goods. Unfortunately, securities markets in these countries tend to be small and thin. Most Latin American countries, even by the standards of other developing nations, tend to be underbanked (the resources of the banking sector are low compared to the demand for credit).

Solving the problem of inadequate financial intervention is therefore an important step in igniting growth in Latin America. This will require tough reforms related to accounting standards, mandatory disclosure, the rights of minority shareholders, and the openness of banking systems to competition. These steps are not only crucial but are independent of the stances countries take with respect to globalization.