On the Record

Latin America, the Global Financial Crisis and the Velocity of Business

Mauricio Cárdenas

Editor’s Note: As the effects of the financial crisis continue to be felt across the globe, much of Latin America should be well prepared to weather the global financial storms with more opportunity for growth. In a speech at the Economist’s 11th Annual Conference on Latin America Private Equity, held in Miami Florida, Mauricio Cárdenas discusses how the United States and Latin American countries can work together, not only on financing and aid, but also on issues like trade, migration, energy, and climate change.

Good morning. Let me start by thanking The Economist for inviting me to this Annual Conference on Latin America Private Equity. It’s really stimulating to see such a turnout of investors, fund managers, current and former government officials, as well as many friends from the financial community in the region.

As some of you may know, I moved from Colombia to Brookings last summer. I am happy to tell you that since my arrival to Washington, Brookings has been ranked by Foreign Policy Magazine as the world’s Top International Economic Policy and Development Think Tank. I mention this not to claim any causality, but really to underscore the fact that Brookings is now a truly global think tank. Part of that spirit is reflected in the recently launched Latin America Initiative which is aimed at improving the quality of public policies no just in the region, but also in the U.S. with regard to Latin America.

Partnership for the Americas Commission

As part of this Initiative, Brookings convened the Partnership for the Americas Commission which has made concrete and pragmatic recommendations to the Obama Administration on ways to reengage the US with Latin America. I am very optimistic about the influence Brookings can have in terms of rethinking hemispheric relations. In today’s turbulent world, nothing would serve better American interests than rebuilding a hemispheric partnership. In fact, hemispheric agreements and cooperation on issues like trade, migration, and climate change could potentially become the cornerstone of global solutions to these daunting problems.

That is why a group of very talented and prominent Latin Americans and American citizens was called to discuss essentially the state of the relationship between the U.S. and Latin America and make some concrete and pragmatic recommendations about ways to enhance that partnership.

Members of the Commission included former Presidents Ernesto Zedillo of Mexico –who was co-chair-; Ricardo Lagos of Chile; Jorge Quiroga of Bolivia; also former Prime Minister of Peru, Roberto Dañino; former deputy Prime Minister of Barbados Dame Billie Miller; former Vice President of Guatemala, Eduardo Stein. The co-chair on the US side was Ambassador Thomas Pickering, former undersecretary of State. Other members included, among others, Mack McLarty, John Deutch, and Strobe Talbott.

Rather than mentioning more names, let me underscore the fact that this Commission generated an enormous amount of consensus. Fortunately, the consensus was achieved not by going to the lowest common denominator. In this talk, I want to share with you a few of the recommendations and their relevance, under the current economic conditions. The fact that the economies of Latin America and the Caribbean have re-coupled so dramatically with the US economy reminds us that there is a strong economic interdependences in the hemisphere. Also, this great interrelation is an opportunity to tackle global problems in a coordinated way, like no other group of developing and emerging countries can do. We know from our own experience in Latin America that crises are opportunities to catalyze change, to push forward in areas where difficult decisions need to be made. A renewed partnership between the US and Latin America can be the best way to move forward the global agenda in areas such as trade, energy, and climate change.

This new approach has to be based on a better understanding of the partners involved. Under its new leadership, the US has a unique opportunity to engage constructively with Latin America. Democratic values and the rule of law are much stronger in LA than in the past. In many countries the private sector is not only more successful on a regional and sometimes global scale, but also is more socially responsible. Political alternations have been smooth, and have not compromised macroeconomic stability. Independent central banks have kept inflation low, and governments of different ideologies have avoided fiscal populism. I know you may be thinking about the obvious exceptions to this rule, but they are just that: exceptions. And with time there will be fewer of them. In general we can say that there has been a positive change in the region during the last decade or so. In other words, this new partnership should avoid mutual recriminations and the Washington propensity to lecture Latin American governments on what to do. Rather, it is about common opportunities and also about the common effort, if we are going to tap those opportunities. Let me sketch a few of them.


Migration is an important issue for the United States because estimates say that, on balance, immigration into the US creates a net benefit perhaps in the vicinity of $50 billion per year. The problem of illegal immigration stems from the fact that there is a mismatch between the need of foreign workers in the US labor market, and the availability of legal workers to satisfy that demand.

The United States actually admits legally almost one million people every year. But according to the best studies available, the US needs 1.5 million workers coming as a flow into this country every year. Clearly there’s a pressure for half a million to come illegally. It is possible that this figure is lower now given the severe economic contraction. But the point is a different one. The United States should confront this problem with policies that recognize the fact that within the next few years the mismatch between the demand and supply of labor—especially in the service oriented sectors– will continue to grow.

One does not have to be an expert to recognize that the only possible solution is an increase in the number of visas and a change in the enforcement system, with a shift in the emphasis from repressive border control—which negatively affects other forms of trade—to more technologically advanced employer-level controls.


It is sometimes little recognized that Latin America represents one-fifth of US exports and imports. The region is a more important provider of oil to the United States than the Middle East. More than one third of the energy used in the US comes form Latin America.

At times when the “Buy American” motto resonates in Washington, it is important to emphasize how damaging protectionism in the US would be for the Latin American countries. As the leaders of the G20 stated last November, rather than recurring to beggar thy neighbor policies this is the time to pursue economic integration through multilateral trade agreements. There is no way that countries like Brazil or Argentina will subscribe to a free-trade area in the Americas if agriculture is not incorporated seriously into such agreement. So, the dream of a free-trade area in the Americas really goes through the Doha Round of global trade negotiations.

While multilateralism is the way forward, it is also true the US has some unfinished business in the bilateral trade agenda. It is unfortunate that the Legislative Branch of the U.S. government is delaying the approval of the Colombia and Panama trade agreements. It is also regrettable that the Obama Administration has not sent a clear signal on the way to move forward on trade issues with these countries. The governments of Colombia and Panama negotiated in good faith, and have made significant compensations in the process. It will be a dramatic disappointment if the US Congress fails to ratify these trade agreements. Failure to do so will pose a very serious problem for the advancement of relations not only between the U.S. and these two countries but I would say it will create a sense of disillusion in the whole region.

Sustainable Energy and Climate Change

Although the demand for energy all over the world may be tempered temporarily as a result of the financial and economic crises, the long run challenges remain daunting. The impact on climate of burning fossil fuels is self-evident and very important. Climate change will have serious effects on agriculture production, on the availability and capacity to produce potable water across the hemisphere, on species loss, on what we see as the potentially increasing destructive power of serious storms in the Caribbean basin.

Latin America needs to coordinate policies on climate change looking toward negotiations, including acceptance of the notion that there is a price for carbon emission, regardless of whether that is dealt with through processes of taxation or processes of cap and trade.

As part of an agreement with the countries in the region, the US should reduce and gradually remove the 54-cent-per-gallon tariff on ethanol, and at the same time remove other subsidies for the use of corn for fuel production. But this is not enough. It is necessary to create other sources of renewable energy, such as wind and solar energies and cellulosic biomass. More research is needed to develop these alternative sources of energy in a cost efficient manner. A research lab located in the in the region and funded by the US would help in this direction.

The future of the hemispheric relations will have to deal with the thorny issue of nuclear energy. Provided that there significant commitments to safeguards to prevent any diversions or proliferation on the one hand and, serious work on the development of waste management processes for the back end of the nuclear fuel cycle, this source of energy will be more widely used in traditionally energy-poor countries, such as Chile.

Another area that will require fresh investments and some form of international cooperation is the integration of energy grids across the hemisphere. In the same way that the U.S. and Canada are tied, interconnecting Central America and across the Darien Gap into the southern portion of the hemisphere is essential to provide stability and confidence that energy supplies can be moved across these grids in ways that will meet demand and adequately benefit from the surpluses in countries that have them. This, of course, will require changes in the regulation, both to open up cross-border infrastructure to the private sector as well as opening up trade in energy.

Drugs and Organized Crime

Let me now turn to protecting the hemisphere against drugs and organized crime. The region has, unfortunately, 27 percent of the global homicides in the world, in excess of 140,000 per year. The US stands at the crossroads of a lot of the drug-related and criminal activity in the hemisphere. Trying to put a large burden on LAC governments to stop the movement of drugs north while 2,000 weapons a day cross the border from the United States to Mexico is a bit oblivious, to say the least. The first thing the US should do is to ratify the new UN protocol on enlisted shipment and trafficking of arms across borders.

Experts and former government officials tend to agree that the war on drugs has not made significant progress. There is a feeling of failure about the current strategy. Prices have not increased, suggesting that efforts to reduce supply have not been all that successful. Eradication has been locally successful, but not on a national or regional scale. Drug producers have the capacity to adapt to the mass eradication technologies that have been employed up until now.

Although some adjustments need to be adopted in regard to supply control -it is important to combine policies that promote alternative livelihoods in a more effective way with better interdiction techniques- the emphasis of the new policies should be on demand side. Some jurisdictions in the US have experimented with innovative ways to reduce consumption and the return of individuals who are now addicted to drugs, rather than locking them up and having them in a sense promote a further education in criminal activity in the prison system. Educational policies and other forms of outreach can also play a key role.

This remains a complicated, deeply interrelated problem that extends all the way from pure narcotics addiction right across the line to political stability in many of the nations of the hemisphere. Demand reduction, in my view, needs to have equal priority with supply interdiction.

Current Economic Conditions

Some would say that this agenda is unrealistically ambitious at times of severe economic stress. It is no secret that the region has taken a dramatic turn. Most analysts and some central banks and governments have been revising their economic projections downwards at unprecedented speed. To give you an example, last July the IMF estimated a 4 percent GDP growth rate for the Western Hemisphere in 2009. In September that figure was lowered to 3 percent, and this past January a new projection of 1.1 percent was released. Some private analysts think now that that this low figure is optimistic. For example, Roubini RGE monitor (now a more credible source than a year ago) is projecting a 0.8 percent growth, very much in line with what Wall Street is now forecasting.

Interestingly, these revisions are being made as bad news arrive both on the domestic front –showing a larger than expected decline in industrial production and in consumer confidence—as well as in international conditions, mainly in US GDP growth.

US Economy

Estimates for output growth in the US for 2009 now range from -1.6 (IMF) to -3.4 (RGE), with the investment banks somewhat around -2 percent. Less than six months ago projections still indicated positive growth for the US this year.

In terms of quarterly figures, there is some debate now on whether the economy will begin to show positive growth by the end of this year. Given the magnitude of the contraction in Q4 of 2008, it is likely that the economy will show some positive growth during the last quarter of this year, but even then is not going to exceed 2.5 percent.

This is not the place for an in-depth discussion about the US economy, but as US housing prices continue to plunge –a 27 percent reduction since peak in the Case-Shiler index (40 percent in Miami)—more mortgages are going into delinquency (and not just the subprime and Alt-A loans), increasing the amount of toxic assets and freezing credit.

That is why an economic recovery is nowhere near, in spite of efforts to stimulate the economy with the fiscal package approved yesterday by the Senate, and the programs announced by Secretary Geithner designed to increase consumer lending and remove toxic assets from banks’ balance sheets. No one is particularly optimistic about the effects of the fiscal stimulus package (with a share of the funds going to tax reductions with particularly low multiplier effect) and there are more than a few pessimistic voices. One would hope that the second drawing of funds from the TARP will be more effective than the first, but is too early to tell.

Economic Conditions in LAC and Transmission Mechanisms

Turning to economic conditions in Latin America, the latest data on manufacturing production are worrisome. Industrial output is contracting at an unexpected pace. December figures are -14.5 percent in Brazil, -3.7 percent in Chile. November figures are -13.3 percent in Colombia and -5.4 percent in Mexico. Peru is the only one of the large economies still showing positive industrial growth. On average, manufacturing production is contracting by 6 percent in Latin America. This is suggestive of the magnitude of the economic shock to the region. However, to really understand the effects of the current crisis we have to isolate –to the extent possible—the various channels of transmission that connect events in the industrial countries with the economic outlook for Latin America.

I will focus on the three that I consider most relevant:

  • Trade in goods and services, including remittances
  • Capital flows
  • Financial Contagion


On the trade aspects, it is a well known fact that Latin America has a relatively high exposure to commodities, although there is some important variation from country to country. The share of commodities in total exports is between 50 and 60 percent in Argentina, Brazil, Colombia. It is 77 percent in Chile, Ecuador and Peru, and 97 percent in Venezuela. The US is the main market for many countries. Exports to the US represent 80 percent of total exports in Mexico, 58 percent in Venezuela, 44 percent in Ecuador, and 35 percent in Colombia.

Given this dependence it is no surprise that both export prices and volumes are receding, and trade balances are moving into negative territory. For example, relative to a year ago prices of industrial metals have fallen by 54 percent, energy products by 53 percent, and agricultural goods by 37 percent lower. Perhaps more worrisome is the fact that ECLAC now predicts a 7.8 percent decline in the terms of trade of the region (30 percent in Chile and Peru, and 20 percent in the rest of the Andean nations). Export volumes are naturally falling as a result of reduced world demand.

Remittance flows to the region are also falling. The most dramatic contractions are seen in Ecuador (-12 percent in September 2008), Guatemala (-5 percent in December, and Mexico (-2 percent in December). Of course, this is particularly problematic for the Central American an Caribbean countries which depend heavily on these flows (they represent more than 10 percent of GDP in Central American nations, with the exception of Costa Rica, –and as high as 22 percent in Honduras (35 percent in Haiti for the record).

Capital Flows

Turning into the issue of capital flows the information is less clear. Data on EMBI spreads is unequivocal on the increased valuation of Latin American risk. Although lower than the levels reached in late October, the Latin America Embi spread is now 690 basis points, almost doubling the level of a year ago. The increase has been proportionally higher in Argentina, Ecuador and Venezuela, which are paying the cost of extravagance. Apart from these atypical cases, spreads have converged to levels around 400-450 bp (reflecting an increase close to 200 bp from February 2008) in countries such as Brazil, Chile, Colombia, Mexico, Panama, and Peru.

The increased risk perception has been reflected on exchange rates. Again relative to a year ago, currencies have depreciated by approximately 30 percent in Brazil, Colombia, Chile, and Mexico. The Peruvian New Sol has lost only 10 percent. Interestingly, currencies have continued to depreciate since last October, even is spreads have stabilized.

Equity markets continue to drop following global patterns. Here there is more dispersion in the decline, ranging from -56 percent in Peru, to -27 percent in Mexico and Brazil, and -11 percent in Colombia. The Chilean IPSA has shown greater resilience to the new environment.

Information on actual capital flows is less reliable. The Institute of International Finances is among the few organizations that gathers information on capital flows. Their current data suggests that net private flows to Latin America fell from 180 billion in 2007 to less than $90 billion in 2008. Their projection for 2009 is $40 billion. This dramatic reduction reflects a reversal in net portfolio equity investment from $15 billion in 2007 to -$10 billion in 2008. Foreign Direct Equity Investment has held up well, but even in this case a reduction from $60 billion in 2008 to $40 billion in 2009 is expected. The sharpest decline is, however, in net debt flows which will be close to zero this year, after exceeding $100 billion in 2007 and $40 billion last year. This is really what will change the economic landscape in the region in 2009.

To summarize, as global portfolios have shifted to U.S. Treasuries and high grade debt securities guaranteed by rich countries, capital inflows have fallen fast. Unsurprisingly, LAC stock markets have joined the global sell off, while LAC currencies have depreciated sharply. Sovereigns are now seeking multilateral finance, while firms, shut out from capital markets, have returned to bank financing at home, crowding out SMEs.

Financial Contagion

This brings us to the issue of financial contagion. Bank credit to the private sector has decelerated, particularly in the consumer segment. Domestic development banks, especially in Brazil, have tried to fill the void. However, the key aspect here is that real domestic credit growth is still positive in most countries. Credit growth remains particularly high in Brazil (25%), Colombia (10%), with lower rates in Chile (5%) and Mexico (0%). Mexico is facing the greatest contagion, possibly due to the larger exposure to international banks which represent 80% of banks’ assets. This explains why there is a 30 percent real decline in consumer credit in that country.

Policy Responses

As inflationary pressures retreat (current projections for the US suggest a 2 percent deflation) central banks in Latin America are now in a much better position to cut interest rates in response to the negative external environment. The reduction in rates from now until the end of 2009 could range from 300 bp in Chile, 200 bp in Brazil, to 150 bp in Colombia, Mexico, and Peru. Of course, if capital flows become increasingly negative the reduction in interested rates will be constrained and central banks may not be able to conduct monetary policy in a countercyclical way.

Fiscal policies, on their part, have been moderately expansionist. Brazil, Chile, Colombia, Mexico, and Peru and Peru have announced stimulus packages. It should be noticed that the capacity of Latin American governments to adopt expansionary fiscal policies is limited. Most countries public finances critically depend on commodity prices. As these prices have fallen deficits have increased. Also, the greater dependence on corporate taxation makes tax revenues more dependent on the business cycle. That explains why fiscal deficits in the region will increase considerably, in spite of relatively modest fiscal stimulus packages. On top of that, financing the larger deficits is an issue in today’s market conditions. In other words, there are limitations to the use of this tool in most countries, with the exception of Chile that can run large deficit (4.5% of GDP) in part because it has accumulated high savings in the past. For countries without those savings the situation is much more difficult.

In Closing

Growth projections for 2009 show an average rate between 1 and 2 percent for the region as a whole. However, there is a significant amount of variation. From Panama and Peru (4 to 4.5 percent) which will outperform other countries, to Mexico (-2 percent), Argentina (-1 percent), Venezuela and Ecuador (0). Somewhere in the middle are countries like Brazil, Chile, and Colombia with growth rates of around 2 percent.

The main message is that the region will be affected by the international crisis, and in a severe way. However, it is clear that the situation is now very different from what happened a decade ago. This reflects the fact that the process of economic reform has brought a high dividend in the form of more resilient and better managed economies. This is fortunate, because it provides not only insulation but also independence to discuss necessary adjustments to the world economy and its financial architecture. Latin American governments should use that greater room of maneuver to advance an agenda that goes beyond the topics of access to financing and aid. This is the time to move forward on issues like trade, migration, energy, climate change, of critical importance of the development of Latin America.

Thank you very much.