Latin America and the Economic Crisis

June 23rd, 2009.
The Brookings Institute.
Washington, D.C.

Thank you.

Well, good morning. Still, it's good morning.

Mr. Kemal Derviş, Vice President of the Brookings Institution, thank you for your kind words. Mr. Mauricio Cárdenas, Senior Fellow and Director of Latin America Initiative, Brookings Institution and still Andrés Velasco, Minister of Finance, dear friends, well, first of all, I would like to tell you that I am very happy to be here, and thank you for inviting me to participate in this seminar, and for giving me the opportunity to share my thoughts with such eminent panelists and such a distinguished audience.

This afternoon, I will be meeting President Obama at the White House. We'll be discussing our responses to the international economic crisis that has just had such major impact on our nations and all over the world. For the last nine months, the government had made the response to the crisis our main priority. We have deployed technical know-how, financial resources and political will to find ways to cushion the impact of the global financial meltdown, so has the U.S. government and much of the world. But this crisis not only has influence in the way in which governments conduct their affairs, it has also put an end to a way of thinking, if I might say, because this is why the title of this seminar is so appropriate: designing and applying stimulus policies. Not only because of that, because we do believe it is important stimulus policy, but also because I think that we should look at the crisis, or -- should I better describe -- we should think at the end of crisis, when better times come, not that we're going to go back to the same situation we were before because that would mean we haven't learned the lessons of the crisis.

So we need to think and reflect and see what are we going to do? What are the kinds of institutions we have to change? What else are we going to have to do to avoid, if possible, a new crisis in the future?

That's why I'm sure not only that everybody says that from every crisis comes an opportunity. I mean, I think it's our duty to try to, after the crisis or within the crisis, to build a better world, better institutions on the basis that we have learned what happened, why the crisis came and what we have to do better. I was talking about one of the issues to responding of the crisis was the idea of designing and applying stimulus policies, and this is very important, because by definition, a stimulus policy reflects the political decision to act decisively, to use the levers of the state and of public policy to stabilize the economy, a political decision to deploy our best public efforts to reverse a major failure on the private side.

This all means that the time has passed for a paradigm that prevailed for too many years and which maintains that the best regulation of the economy is no regulation at all, and this was an almost blind belief that markets, no matter how complex, can solve in a magical way the countless market failures, informational asymmetries and conflicts of interest that arise -- the belief vigorously advocated in this very city not too long ago that the state is part of the problem, not the resolution.

Well, we believe that the state is part of the solution. This approach to no regulation and only the state is part of the problem is an approach that in Chile we have come to call the Paradigm of Passivity. The crisis has taught us that what we should have known all along, that the state is not and cannot be passive when it comes to economic activity or to financial regulation.

But do not take me wrong. I do not want to be misinterpreted in what I am saying. When I talk about not being passive, I'm not necessarily talking about an interventionist state. I'm not calling for a government involved in all sectors of the economy or prone to overregulate markets. When I talk about not being passive, I'm referring basically to three things:

First of all, public policy must pay great attention to potential and actual market failure and must use pro-market rather than pro-business tools in an effort to strengthen markets and make them more competitive.

Second, just as the micro economy does not self-regulate, neither does the macro economy. John Maynard Keynes made the point six decades ago, and the crisis has brought it home unambiguously and with painful force: We need a state that uses fiscal, monetary and financial policies countercyclically.

Third, good economic policy and good social and environmental policy are one and the same. Social cohesion and green growth are goals that can and should go hand-in-hand. For this to happen, we must design such policies in a smart way, so that they can be financeable, sustained over time.

It is for these reasons that I favor an active state, rather than a passive one. But keep in mind that an active state is not the same as an interventionist state. Bearing the three elements in mind, we can now talk about stimulus policies. Chile and Latin America have been affected by this crisis, and not only financially but especially in the real economy. The initial shock was financial. Starting in September of last year, appetite for risk went down, the spreads went sharply up, and access to financing became much more difficult for governments and companies in the region.

But this time in Latin America, fundamentals were better and the policy response was swift. The region's central banks moved quickly to offset the lack of liquidity in dollars, using either sovereign funds or international reserves accumulated during the commodity boom earlier this decade. In addition, this time around, the region's banks were mostly well regulated and healthy, I must say. This is one area where regulation helped, and hugely so. In the case of Chile, we had this crisis in the ‘80s. We learned lessons. We introduced regulations. So our financial system was really in very good condition.

Unlike the U.S. and much of Europe, in 2009, Latin American taxpayers have not had to bear the burden of bailing out their local banking system. Earlier lending and regulatory prudence has paid off. But we should not overdo caution, however, when it comes to lending today. Healthy banks can and should lend and support the recovery plans of our region's firms. In Chile, we have adopted measures both to stimulate bank lending and to bring competition from other players: insurance companies, credit unions and bonds investors.

After the financial shock came the real shock. The collapse of global demand and a sharp slowdown in world trade have been particularly detrimental in Latin America. And I would say in Central America, it has been very important, too. Our open economies in the region have felt the impact both in the demand for their exports and the price of the goods they sell abroad. Dealing with this shock has been made easier by the adoption of flexible exchange rates and by the use, wherever possible, of countercyclical monetary and fiscal policies.

Please allow me now to tell you a bit about the way in which we have reacted to the crisis in Chile, although I know that probably Minister Velasco for sure must have also referred to some of those issues. It should not be a surprise that such a deep external crisis would affect an economy like Chile's, which depends to a large extent on foreign markets. In the past, it was a wonderful choice, but you cannot win every day. We had a wonderful choice and we'll continue going there, but of course, we have felt the impact.

Our terms of trade fell 25 percent during the last quarter of 2008 if we compare to the last quarter of 2007. The values of exports dropped at a similar rate. In 2009, our partners will experience negative growth of nearly 1.5 percent. These are big shocks indeed, and that is the bad news. The good news is that we spent the last decade preparing to face such shocks. In 2006, we passed a fiscal responsibility law that gives our fiscal policy a long-term approach. We spend only permanent revenues and save windfall income, for instance, from copper, in two rainy day funds.

Please allow me to give you just one piece of information: Our sovereign wealth funds hold today more than $20 billion. Can you imagine what enormous political will it takes to accumulate such funds without succumbing to populist temptations? Or, how I said in the past, how much more popular I would be if I would be populist? In the two years ending in December, 2008, we have earned more than $2.3 billion, thanks to present and transferent administrations. Our funds hold no corporate bonds and no equities, and as a result, they may be the only sovereign funds on the planet that have not lost money during the crisis.
All of this has earned us recognition from abroad. Just to mention one example, the Swiss Institute for Management Development, IMD, ranked Chile as one of the countries that is best prepared to resist external shocks. Chile was placed not only above the average of emerging countries and above Latin America, but also above China and the average of advanced countries of the OECD.

But what about stimulus policy? On January 5th, I announced with the Minister of Finance our fiscal stimulus package for 2009, equivalent to 2.8 percent of the GDP. According to IMF figures, it is the fifth-largest in the world as a share of national income. This package was designed to inject resources directly into the pockets of the most deprived families, to promote employment by increasing public investment, and granting subsidies to youth employment and to encourage private investment with temporary tax rebates. Since January, we have added a number of complementary economic incentives. First of all, I will have to tell you that, as I said before, last year, we decided for this year our priority will be how we respond to the crisis and how we respond to the crisis so the crisis won't hurt the more vulnerable families and how we work in order to respond to the usual unemployment that is during and after the crisis.

So we have been doing all of this, and I'm telling you, but not only a big announcement. We are working every day in the field, in the region, following the money and the investment, I would say - following employment and unemployment really into great details. I am saying it really because myself I've been traveling to all the regions, discussing with the regional governments, seeing if it works or doesn't work. And, if doesn't work, why? And we have added different initiatives that were necessary, because, for example, we were assured liquidity but banks were not lending the money to the people. So that's why we decided on the first stimulus plan. But then afterwards, if they have new things that we needed to improve and to change, we have been doing.

So as I told you, after January, we launched a lot of other initiatives. In March, for example, because of the problem with access to credit for consumers, we launched the pro-credit initiatives in an attempt to increase access to credit for consumers and for smaller companies and to strengthen the capital market.
In April, in a historic agreement with labor and business leaders, we launched a number of novel labor market mechanisms to discourage layoff and stimulate worker training, because at the first, we decided that a lot of money, $700 million, for public investment in order to generate more employment. We know that in Chile, 8 from every 10 jobs is produced by the private sector. So we said, okay, let's try to generate employment, but let's protect the employment that is already there and let's protect the workers that sometimes will be unemployed.

And, in May, I announced an additional bonus payment for low income households and an insurance system to keep students from having to quit college in case a parent should lose their job. This was made for us. I mean, we have said we are going to be a developed country in the future, and human people and youth, our human capital, it's so important. So it's not possible that because the parents lose their job that the students have to quit university. So we developed a special system in order to assure that.

But fiscal stimulus is not the end of the story. I should also mention the consecutive cuts in interest rates applied by the Central Bank of Chile since the beginning of 2009. Only one other central bank in the world has cut the target rate as much since the beginning of the year. In short, we have acted decisively and committed resources. Forgive me for saying that this manner of facing a crisis is unprecedented in Chile and, I don't know, maybe in Latin America. I don't mean to be arrogant, but I think it was a pretty new way of doing things.

Why are we able to act like this today? Because we have acted responsibly in the past. We have the resources for this plan because I am sure many countries know what they have to do, but they don't have the resources to do it. And we don't do it by accident. I mean, we don't have the resources by accident. It's not an accident. It was a decision, a political will to be able to have resources for the moment where the economy won't go very well.

But we did not only think that it was so unjust that the workers, the poor people, the more vulnerable ones should have the impact of the crisis. So we do not only maintain social expenditure, but we increase it. We have shown that responsibility in politics pays and pays a great deal. At first, one witnesses pressure being accepted from all sides, I would say, not only from the opposition but also from the friends who thought we have a lot of money and let's use it now. Of course, there is a high cost to be paid if one resists those pressures. It is tough indeed. But after a while, responsible behavior starts to reap its rewards.
Chile could not be immune from such a deep crisis. We knew that full well. After having achieved an annual growth rate of 4.2 percent during the first three quarters of 2008, growth dropped to only 0.2 in the last quarter of the year. And during the first quarter of 2009, there was a contraction of the economy of 2.1, if you compared it with the same period of the previous year. But in spite of those figures, we are committed that we will overcome this crisis.

Several markets which have slowed down, among them real estate sales and construction, have begun to show signs of recovery, and I believe we will be seeing further signs of recovery in the second half of this year. We will keep our strategic bets to be well prepared for the postcrisis world. We have not only kept by increasing our budget for innovation and technology adoption. We are building clusters around key export sectors, striving to take advantage of our competitive edge in certain niches.

We will also continue investment in education, human capital accumulation and worker training. In the midst of this crisis, the Chilean Government is increasing four-fold each year the number of students who go abroad to pursue post-graduate study. As a matter of fact, in the United States, we have two kinds of programs: one called Equal Opportunities, that we designed with the government two years ago, and one with California, Chile-California plans, and we send abroad a lot of our students.

I don't know if Minister Velasco told you because when copper was very high, we developed a special fund called the Bicentennial Fund. This is not a sovereign fund. It's another. It's $6 million whose interests are to send our students to study abroad. Why I tell you this is because in the past, in the ‘60s, we signed the first Chile-California program. We went there like to ask for scholarships, to ask for credits, to ask for a lot of things. Now we have a more partner-to-partner relationship because we were responsible. We decided to invest in our people. And now we can send abroad a very high number of students that will help us to improve the capacity of our human capital, the capacities of our universities, and then we really could meet the goal of being a developed country in the future.

We also developed innovative energy policies aimed at promoting less contaminating energy, and this is one of, I would say, not the more relevant but a very relevant area of cooperation with the United States. Some hours ago, we just signed an agreement between the National Commission of Energy and our Minister of Energy, and this is one of the areas where we are going to work with Obama's Administration very strongly. And I always say that if we use trillions and trillions of dollars being used to respond to the crisis in identifying or developing new ways and new technologies in order to also tackle with climate change, we'll be doing things great.

As a result of the visit, as I told you, the United States and Chile will make progress together in solar energy, ProEx in the north of Chile. I don't know who -- I mean, not the Chilean ones but the rest of the people who have ever been to the Atacama Desert. Well, it's the driest and some people say it's the desert where you can find more solar energy. So we're going to do great plans there.

Well, dear friends, let me end by asking: What is it that we have learned from this crisis? Very briefly, of course. First of all, we would need to change our mindset to understand that the time has come for the state to act. Second, even in the midst of the crisis, we must keep our eyes trained on the future. Growth will resume when trust is recovered, when people start investing again and when families return to their normal consumption pattern. Of course, there are no magic formulas to this other than trying to make markets function properly again. And, third, when I said that we need the state to be active, I was meaning not only in the restrictive point of view. I was always thinking multilaterally because I think the response is global, and if we don't respond globally it's very difficult that any country at all can solve completely their problems. So I think we still need to go further. And when I said the post-crisis world, it means also the post-crisis institutions, because Bretton Woods institutions were wonderful for after the Second World War, but now it's time to introduce all the changes of a new world, where you have a lot of emerging powers who were not as strong in the past, and now you need to incorporate it more vigorously in the institutions. And we need to find ways of how institutions can, I would say, have early warning systems, prevent this sort of things, and also have quicker response.
Also, I would say have more transfer in more democratic ways of organizing. I think we need really a reform of the institutions, even though I have to say I understand there are times for things and times for other things.

I always use because we are an earthquake country, that if you have an earthquake right now -- don't get scared. It's just symbolic. And the building comes upon our heads. Probably, the first thing everybody, the police and firefighters will do, is rescue us. But then you will have to build the building again. Of course, so there is a time for rescue plans, but there is a moment also for building a new infrastructure, a new institutionality that will mean that in the future an earthquake won't bring the building down. I think it's the same thing with the crisis. We need to do both things because sometimes you feel people are thinking "No, we have to do A" and the others say, "We have to do B." We have to do both. We have to rescue, to help recover the economy, but also we need to make the changes in institutions that will assure us, assure our peoples, that things like this won't happen again or, if it will, they will be made better prepared for it.

I would say, third, we need strong political will to make hard decisions when we have to, to avoid getting carried away by pressure of all sorts, and to convince the population that the chosen road is the best for everybody. And I say that because, as I mentioned before, when we developed this policy of fiscal responsibility and neither populist nor much popular, it wasn't very popular at all. But now people understand that was the best choice because now we can. We do have what we need to make what we have to do. As I said, being popular is not the same as being populist. But I think it's more serious, responsible and, in the case of Chile, it works.

So thank you very much.