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Economic reform and stabilization in Latin America
IOURNALOFCOMPARATIVEECONOM~CS
13,597-599(1989)
Eds.,EconomicReform and Stabilization in Latin America. New York: Praeger, 1987. xxiii
MICHAEL CONNOLLY, AND CLAUDIO GONZALEZ-VEGA,
-t 348 pp., $47.50. This volume covers a wide area, from trade liberalization to the financially repressed economy, passing from economic theory to policy-making. It de serves to be read by international economists and by economists with an interest in Latin America. The first two parts of the volume are devoted to the theoretical aspects of liberalization and to the order of trade and financial liberalization. Guillermo Calvo demonstrates that temporary liberalization-stabilization policies may be costly and that the cost can be substantial. Brock and Tower examine the conditions under which liberalization can be successful, necessitating in particular a devaluation in real terms. They also analyze the consequences of capital inflows in a liberalized economy. These consequences are investigated further by Khan and Zahler who emphasize that opening up policies must be supported by domestic macroeconomic management. Edwards and Van Wijnbergen address the question of the order of liberalization of goods and capital markets. They build on the literature on immiserizing transfers to reach the conclusion that opening up capital markets while restricting trade is undesirable. In turn, Blejer and 8agari discuss the modalities of domestic financial liberalization which they consider to be a precondition for external financial liberalization. The choice of the appropriate exchange rate regime is the subject of Part III of the volume. Two of the papers deal with Chile and one with Mexico. Sergio de la Cuadra reviews Chilean exchange rate policies in the 1933- 1982 period, examining domestic and external factors that occasioned devaluations. He claims that the decline in the terms of trade and the expansionary policies followed by the central bank led to the devaluation of 1982. This appears to be a partial view as it neglects the deterioration of Chile’s competitive position brought about by exchange rate overvaluation and the large external borrowing by the nontraded goods sectors, which are emphasized by Vittorio Corbo. Rather than a fixed exchange rate as in 1978- 1982 in Chile, Mexico applied a system of preannounced pegs in 1982-1985. Connolly et al. attribute the breakdown of this experiment to overly rapid credit creation, falling oil prices, and the large fiscal deficit prior to the July 1985 election. There is a contrast here with Chile where a devaluation became necessary despite a prudent fiscal policy. 597
0147~5967189 $3.00 COpyrigbt 0 1989 by Academic Press, Inc. All rights of reproduction in any form reserved.
598
BOOK
REVIEWS
Part IV of the volume is devoted to the experience of the Dominican Republic, where the conference at which the papers of the volume were presented was held. Victor Canto provides evidence that domestic money creation has induced both the dollarization of the economy and the exchange rate depreciation. In turn, Gonzalez-Vega and Zinser show that financial repression leads to increased income inequalities as small savers do not have access to higher-yield deposits and loans are oriented toward larger borrowers. In Part V on the liberalization experience of Chile and Uruguay, Arnold Harberger presents a primer on the Chilean economy while Jaime de Melo focuses on Uruguay. Harberger suggests yet another explanation for the 1982 Chilean devaluation. In his view “the unconscionable rise in the unemployment rate, rather than anything connected with the loss of foreign reserves, triggered the devaluation of 1982” (p. 222). Unemployment rose as the fixed exchange rate was in conflict with the backward indexation of wages. At the same time, Harberger takes an optimistic view of the future of the Chilean economy that has been borne out by recent events. Jaime de Melo reexamines the question of the order of trade and financial liberalization. He finds that “while the Uruguayan experience is not sufficient to establish a case against opening the capital account before the current account, it suggests caution in pursuing such a course” (p. 238). At the same time, domestic financial liberalization has brought benefits in the form of higher private savings and investment. There is only a single paper in Part VI, Trade Policy: “Trade Liberalization, Preferential Arrangements, and their Impact on U.S. Imports from Latin America” by Edward Ray. The conclusion is reached that preferential trade arrangements with the developing countries of the Western Hemisphere, in the form of the General Scheme and Preferences and the Caribbean Basin Initiative, do not compensate for the discriminatory effects of U.S. tariffs and nontariff barriers on the structure of imports from these countries. Nor do the countries in question benefit from intraindustry trade that occurs largely in producer goods. Part VII contains two papers on financial reform. Andres Dauhajre set out to translate Van Wijnbergen’s macroeconomic portfolio model into a flexible exchange rate framework with perfect capital mobility. It is shown that, under certain conditions, financial reforms may have adverse effects on economic activity in a small, open economy but policy makers possess the instruments that can eliminate these adverse effects and guarantee that financial reforms generate the desired effects of the deepening of financial markets. Burkett and Vogel analyze the microeconomic foundations of financial liberalization, involving the integration of the portfolio and inventory ap proaches to the demand for money. In particular, taking account of transaction costs will strengthen the result that higher interest rates lead to increased holdings of financial assets.
BOOK REVIEWS
599
There are two papers in Part VIII, The Financially Suppressed Economy. John McDermott shows that combining several controls over economic ao tivity may enhance the negative consequences of each. The paper gives particular emphasis to the adverse employment effects of foreign exchange rationing in the presence of minimum wage laws. Finally, Lynn McFadden provides estimates of government revenue from money creation in Latin America. It is shown that in several countries, including Argentina, Peru, and Mexico, such seigniorage revenues surpassed 5% of GDP. In view of the large number of topics covered, this review has provided a general overview of the volume without attempting to analyze any of the contributions. It is hoped that this will induce the reader to peruse the many interesting contributions to the volume. BELABALASSA The Johns Hopkins University Baltimore, Maryland 21218
13,597-599(1989)
Eds.,EconomicReform and Stabilization in Latin America. New York: Praeger, 1987. xxiii
MICHAEL CONNOLLY, AND CLAUDIO GONZALEZ-VEGA,
-t 348 pp., $47.50. This volume covers a wide area, from trade liberalization to the financially repressed economy, passing from economic theory to policy-making. It de serves to be read by international economists and by economists with an interest in Latin America. The first two parts of the volume are devoted to the theoretical aspects of liberalization and to the order of trade and financial liberalization. Guillermo Calvo demonstrates that temporary liberalization-stabilization policies may be costly and that the cost can be substantial. Brock and Tower examine the conditions under which liberalization can be successful, necessitating in particular a devaluation in real terms. They also analyze the consequences of capital inflows in a liberalized economy. These consequences are investigated further by Khan and Zahler who emphasize that opening up policies must be supported by domestic macroeconomic management. Edwards and Van Wijnbergen address the question of the order of liberalization of goods and capital markets. They build on the literature on immiserizing transfers to reach the conclusion that opening up capital markets while restricting trade is undesirable. In turn, Blejer and 8agari discuss the modalities of domestic financial liberalization which they consider to be a precondition for external financial liberalization. The choice of the appropriate exchange rate regime is the subject of Part III of the volume. Two of the papers deal with Chile and one with Mexico. Sergio de la Cuadra reviews Chilean exchange rate policies in the 1933- 1982 period, examining domestic and external factors that occasioned devaluations. He claims that the decline in the terms of trade and the expansionary policies followed by the central bank led to the devaluation of 1982. This appears to be a partial view as it neglects the deterioration of Chile’s competitive position brought about by exchange rate overvaluation and the large external borrowing by the nontraded goods sectors, which are emphasized by Vittorio Corbo. Rather than a fixed exchange rate as in 1978- 1982 in Chile, Mexico applied a system of preannounced pegs in 1982-1985. Connolly et al. attribute the breakdown of this experiment to overly rapid credit creation, falling oil prices, and the large fiscal deficit prior to the July 1985 election. There is a contrast here with Chile where a devaluation became necessary despite a prudent fiscal policy. 597
0147~5967189 $3.00 COpyrigbt 0 1989 by Academic Press, Inc. All rights of reproduction in any form reserved.
598
BOOK
REVIEWS
Part IV of the volume is devoted to the experience of the Dominican Republic, where the conference at which the papers of the volume were presented was held. Victor Canto provides evidence that domestic money creation has induced both the dollarization of the economy and the exchange rate depreciation. In turn, Gonzalez-Vega and Zinser show that financial repression leads to increased income inequalities as small savers do not have access to higher-yield deposits and loans are oriented toward larger borrowers. In Part V on the liberalization experience of Chile and Uruguay, Arnold Harberger presents a primer on the Chilean economy while Jaime de Melo focuses on Uruguay. Harberger suggests yet another explanation for the 1982 Chilean devaluation. In his view “the unconscionable rise in the unemployment rate, rather than anything connected with the loss of foreign reserves, triggered the devaluation of 1982” (p. 222). Unemployment rose as the fixed exchange rate was in conflict with the backward indexation of wages. At the same time, Harberger takes an optimistic view of the future of the Chilean economy that has been borne out by recent events. Jaime de Melo reexamines the question of the order of trade and financial liberalization. He finds that “while the Uruguayan experience is not sufficient to establish a case against opening the capital account before the current account, it suggests caution in pursuing such a course” (p. 238). At the same time, domestic financial liberalization has brought benefits in the form of higher private savings and investment. There is only a single paper in Part VI, Trade Policy: “Trade Liberalization, Preferential Arrangements, and their Impact on U.S. Imports from Latin America” by Edward Ray. The conclusion is reached that preferential trade arrangements with the developing countries of the Western Hemisphere, in the form of the General Scheme and Preferences and the Caribbean Basin Initiative, do not compensate for the discriminatory effects of U.S. tariffs and nontariff barriers on the structure of imports from these countries. Nor do the countries in question benefit from intraindustry trade that occurs largely in producer goods. Part VII contains two papers on financial reform. Andres Dauhajre set out to translate Van Wijnbergen’s macroeconomic portfolio model into a flexible exchange rate framework with perfect capital mobility. It is shown that, under certain conditions, financial reforms may have adverse effects on economic activity in a small, open economy but policy makers possess the instruments that can eliminate these adverse effects and guarantee that financial reforms generate the desired effects of the deepening of financial markets. Burkett and Vogel analyze the microeconomic foundations of financial liberalization, involving the integration of the portfolio and inventory ap proaches to the demand for money. In particular, taking account of transaction costs will strengthen the result that higher interest rates lead to increased holdings of financial assets.
BOOK REVIEWS
599
There are two papers in Part VIII, The Financially Suppressed Economy. John McDermott shows that combining several controls over economic ao tivity may enhance the negative consequences of each. The paper gives particular emphasis to the adverse employment effects of foreign exchange rationing in the presence of minimum wage laws. Finally, Lynn McFadden provides estimates of government revenue from money creation in Latin America. It is shown that in several countries, including Argentina, Peru, and Mexico, such seigniorage revenues surpassed 5% of GDP. In view of the large number of topics covered, this review has provided a general overview of the volume without attempting to analyze any of the contributions. It is hoped that this will induce the reader to peruse the many interesting contributions to the volume. BELABALASSA The Johns Hopkins University Baltimore, Maryland 21218