2005 Spring Forum

Ricardo Hausmann Discusses Emerging Country Growth at EMTA Spring Forum
Harvard Professor and former Venezuelan Minister of Planning Ricardo Hausmann delivered the keynote address at EMTA’s Spring Forum on April 21, 2005. In his presentation, Hausmann proposed a new approach to looking at emerging country growth and suggested a new focus for policymakers. The Forum was hosted by Bear Stearns in New York City and also included a panel discussion and cocktail reception.

In his introduction, Hausmann noted that a number of countries have "done what we thought was the secret of what you needed to do in order to achieve growth," yet have disappointed observers because of their failure to achieve substantial economic progress. Such countries, which include most of those in Latin America as well as Morocco and South Africa, have undergone years of political reform, have achieved macro-economic stability, have received praise for structural reforms from the multilaterals, have attained better credit ratings, and have improved their education systems, but are still not achieving the higher GDP rates they had been assured would follow as a result.

This disappointment has led policymakers and academics to develop a new consensus that additional reforms must also be prerequisites to greater growth; the task list has been amended to include judicial reform, corporate governance issues and other goals. As analysts promote this new policy prescription, Hausmann questioned whether the factors assumed to promote growth in the future could actually explain historical growth. In fact, he opined, "we are finding out that we are really lousy at explaining the past."

In Latin America, Hausmann continued, Chile has served as the unrivalled model economy for its neighbors. "Policies in other Latin American countries have tended to converge towards Chilean standards—Chilean-style trade policy, Chilean-style financial policy, Chilean-style social security reform, Chilean-style privatizations…but they have not resulted in Chilean-style growth," he noted ironically. Hausmann added that this was borne out in an analysis of data which showed that, despite a general convergence towards Chilean reforms, per capita income in Latin countries increasingly diverged from those in Chile between 1985 and 1999.

Hausmann spoke critically on the validity of the "Chilean miracle" as the right model in any case, as in a more global context South Korea’s per capita income has made dramatic gains vis-à-vis US levels over the past 50 years, while Chilean income actually remains at the same level as fifty years ago. "So they have all tried to copy Chile, and Chilean outcomes don’t even look that great in a global sense," he asserted.

Hausmann advised his audience that, in order to identify the binding constraint, one must take into account physical capital, human capital, infrastructure and institutions. He emphasized that these factors were complements, and pointed out that the marginal return on the binding constraint would be pushed up while simultaneously depressing the country’s overall economic output. "If you have five right shoes and three left shoes, having more right shoes is not going to allow you to have more variety, so if the binding constraint is the left shoe, don’t put a lot of effort into making more right shoes," he explained.

In order to identify the most binding constraint, one has to begin a Socratic process, developing a sort of decision tree on possible impediments to growth. At the first level, the analyst must decide whether the main constraint is the lack of attractive investments (i.e., low returns on investment) or inadequate access to funding. This leads to several additional rounds of questions and eventually the binding constraint can be identified, according to Hausmann.

In the past, the lack of growth in emerging countries has frequently been analyzed in a similar fashion—"sort of like all unhappy families are the same, but as Leo Tolstoy said in Anna Karenina, all unhappy families are unhappy in their own ways," he analogized. While the Washington Consensus has been a sort of one-size-fits-all policy recommendation, Hausmann countered that each country might be bumping up against unique problems.

Brazil was discussed by Hausmann as a contrasting case. On the first level of the decision tree the constraint in Brazil lies in the direction of inadequate funding, due to high local interest rates. Hausmann traced further down his decision tree to identify low domestic savings as the binding constraint on the economy. As a result, Hausmann’s recommended therapy for Brazil would be to cut government consumption to increase aggregate savings in the economy.

In conclusion, Hausmann recommended that once policymakers identify an economy’s binding constraint, they should determine what the appropriate policy to relax that constraint is. In the future, policymakers should also institutionalize this process so that over time, as conditions change, new binding constraints can be identified and addressed.

Hausmann’s presentation is available on the EMTA website at http://www.emta.org/media/ffdolccw/aeba3b8e-0277-4cd8-abf9-40e3d99a65cd.pdf.

UBS’s Michael Gavin commented that he was firmly convinced that the stage had been set for the relaxation of inflationary pressures in Brazil, and added he did not have near-term concerns about the political environment either. Over the medium term, Gavin stated he was probably on the "cautious end of the spectrum" on views on Brazil. "The frequency with which I am hearing the question ‘when is Brazil going to be investment grade?’ lately makes me think that maybe a little complacency or over-optimism has slipped into investors’ views—it’s still a question of if, not when," he declared. On Mexico, Gavin recognized that he was "moderately more bullish" than the market, forecasting growth of just over 4%.

Whitney Kane-Gomez (Morgan Stanley) offered her assessment of the Andeans, focusing on the recent ousting of Ecuador’s President Lucio Gutierrez. Kane-Gomez described initial indications from the new administration as "alarming," and cautioned that "we have lived without the threat of a default in the Andeans, but that has changed today." The country’s debt is likely to be a top priority for the government, "and in addition, we are seeing a significant shift in the kinds of people that will be on the economic team," she warned. On the other hand, Kane-Gomez speculated that perhaps "we haven’t gotten to the end of this chapter of political noise," noting that the new president was among the targets the protesters had recently been trying to remove from office, and that military support of the new leader was not immediately forthcoming. Early elections might be brought about by both domestic and external pressures, she suggested.

Kane-Gomez spoke positively on the remaining Andeans, highlighting the region’s robust growth, record exports, declining unemployment and increasing foreign exchange reserves. The facts that liability management has entered the public consciousness and local markets have been deepened and broadened are encouraging, she reasoned. However, the failure of the oil sector in Colombia, Ecuador and Venezuela to attract new investment could be a concern if oil prices do not remain at current levels.

Michael Gagliardi of Trust Company of the Atlantic addressed the election cycle in Emerging Markets, expressing his surprise to have discovered that 60% of EMBI+ countries would undergo elections within the next 18 months. "If I’ve learned anything, it’s that politics is always an event," he affirmed. He concurred with much of Kane-Gomez’s assessment of Ecuador, expecting further "disruption and noise," but confessed that he was probably getting ready to make some opportunistic purchases, betting that the market’s worst fears would not actually materialize.

Gavin excused himself from commenting on the restructuring due to UBS’ role as a deal manager, but noted he was somewhat more pessimistic than the market about 2006. He predicted that an Argentine accord with the IMF would remain politically difficult unless holdout creditors were addressed. "When the government puts a law on its books saying it is not allowed to deal with the bonds that are still in arrears, then lending to that government is pretty close to lending into a repudiation, and I do not think the G-7 or the IMF want to go that far," he explained.

Rolley further discussed his interest in the growth of offshore fixed rate, fixed maturity debt markets in such currencies as the Brazilian real and Colombian peso. He speculated that through such markets the foreign investor could play a constructive roll in the building of more robust capital structures in instances where local investors might have a "genetic aversion" to investing in local debt due to hyperinflation in the past.

Moderator Ross polled speakers for their 2005 asset class forecasts. Kane-Gomez predicted a return of 0 to 2%, acknowledging that she had become more bearish since calling for a 5% return earlier in the year. Kane-Gomez thought Argentina and Venezuela could do well this year, but had recently had a change of heart on Mexico and now believes it will be an underperformer.

Gavin seconded Kane-Gomez’s lack of enthusiasm for the market this year, adding "there is meaningful downside possible in the market this year from current levels, although a downdraft similar to the one last year is unlikely." Gavin recommended avoiding higher â credits such as Southern Cone countries and Colombia. Rolley believed that "you could find teenage returns if you participate in selected local markets," but reiterated his earlier lack of optimism on external debt returns for the year.

Gagliardi echoed Rolley’s comments that the "hard currency markets are not very sexy." Borrowing Dr. Hausmann’s analogy, Gagliardi described the market as evolving from one in which "we were buyers and sellers of shoes" to one in which "we are going to have to be makers of shoes, and we will do that by using some of these markets that Dave Rolley alluded to." Sub-Saharan local markets have attracted Gagliardi’s attention, and he confirmed his participation in the Nigerian and Zambian local markets, while admitting to also playing more "crowded fields" such as Brazil.

Rolley thought Peru might reach investment grade, "depending on what a President Garcia has in mind!" However, an investment grade rating is unlikely for Argentina, Rolley surmised, unless the country’s constitution is amended to impose budget constraints on the provinces.