Sustaining Latin American growth

• Author: James L. Rowe
• Position: IMF External Relations Department
• Pages: 10-11

Page 10

Latin America may be in its third year of economic recovery with reasonable prospects for next year, but that is not quite enough to banish the ghosts of decades of starts and stops. Against the backdrop of current growth, the IMF's Western Hemisphere Department convened a day-long conference to examine the recent research of IMF economists and outside specialists on the issue of economic growth-perhaps the most important factor in poverty reduction- and the outlook for continued expansion in Latin American and Caribbean countries.

Two issues in broader growth theory provided a basis for the day's discussions: the role of foreign capital in the economic growth of developing countries and how to make growth spells last longer. Standard economic models suggest that capital should flow from rich countries to poorer countries because the investment opportunities are more productive in countries that have a low capital-to-labor ratio. But the IMF's Arvind Subramanian said that, increasingly, capital is flowing from poorer to richer ones. Moreover, poor countries that ran current account surpluses, not relying on foreign financing, have tended to grow faster than countries that ran current account deficits.

There are several potential explanations, Subramanian said. Research that he and IMF colleagues Eswar Prasad and Raghuram Rajan did in their paper "Foreign Capital and Economic Growth" found that external capital may not be needed in countries that generate more domestic savings than can be put to productive use. Or foreign capital may not help in countries that do not have the capacity to absorb it. In some instances, foreign capital could be helpful, but financial systems are insufficiently developed to harness it. He said that foreign direct investment (which often does not rely on the domestic financial system) tends to behave more in line with the standard model.

There is, he added, a less benign reason for lower inflows of foreign capital: it can hurt development. Countries may avoid capital inflows because they lead to overvalued currencies, which, in turn, hurt competitiveness in key sectors, such as manufacturing.

Starting and stopping

When it comes to growth, many developing countries, including those in Latin America, have historically not had trouble getting it started. The problem has been an inability to maintain the type of...