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Latin America: The crisis of debt and growth
196
Book reviews
Thomas O. Enders and Richard P. Mattione, Latin America: The Crisis of Debt and Growth (The Brookings Institution, Washington, DC, 1984) pp. viii + 66, $6.95. The central thesis of this study is that Latin American countries now face a tradeoff between promoting domestic growth and servicing their external debt: a decision to promote growth induces a debt crisis whereas a decision to service the external debt creates a crisis of growth. In view of this tradeoff, Enders and Mattione focus on the policies that Latin American countries might implement to avoid either crisis. To this end, they examine the causes that led to the Latin American debt crisis and the policies which can be implemented to resolve it. Causes of the debt crisis
According to Enders and Mattione, the debt crisis of 1982 was precipitated by external shocks, borrowers' inadequate domestic policies, and constraints in the supply of foreign credit. With few exceptions, external shocks reduced the availability of foreign exchange to buy imports and to service the debt. These shocks included increases in interest rates, higher oil prices, lower commodity prices, and slower growth in industrialized nations. (The estimation of these foreignexchange reductions is important for the analysis because they are used to evaluate domestic policy responses in Latin America.) However, Enders and Mattione assume that import and export volumes have a zero price elasticity, which is a very restrictive assumption. For example, the loss in foreign exchange reserves associated with an oil shock is estimated by applying the increase in oil prices (relative to a base period) to a given volume of oil imports. A similar procedure is applied to estimating the impact of the other external shocks. Inadequate domestic policy responses to the external shocks may have contributed to precipitating the debt crisis in Latin America. (Inadequate policy responses might have contributed to prolonging the debt crisis.) As Enders and Mattione indicate, the difficult question is how to determine whether these policy responses were inadequate. As suggested above, they argue that a policy response is inappropriate if the observed deterioration of the current account exceeds the estimated loss in foreign exchange associated with the external shocks (p. 18). I do not find their criterion for policy evaluation particularly useful. First, it assumes that the current account balance is the overriding objective of domestic policies. Although there are short periods of time when such an overriding objective might be justified, long run policy concerns, such as the tradeoff between equity and efficiency, reducing inequalities in the distri-
Book reviews
197
bution of income, or the creation of an infrastructure, are as important as the current account in the overall policy mix. Second, even if the current account w e r e the sole concern of policy-makers, there is no guarantee that the implementation of the 'correct' policy mix will be successful. Ex-post, the 'correct' mix might appear as ineffective because of unanticipated shocks. The third reason for the development of the debt crisis is the cutback in bank credit due to a shift in lenders' perception of borrowers' ability to service further increases in debt. The decline in oil prices and Mexico's suspension of payments on principal may have contributed to such a shift. Enders and Mattione, however, give relatively little attention to these credit constraints, which is regrettable in light of their findings, as we will see below. The conclusion drawn by Enders and Mattione is that the Latin American debt crisis was not so much due to external shocks or credit constraints, but rather the result of inadequate domestic policies. The logical implication of this conclusion is that the solution to this crisis lies in the implementation of domestic policies more conducive to promoting both growth and debtservicing capabilities, the analysis of which occupies the rest of their study. Solutions to the debt crisis
The analysis starts with the construction of a baseline case for the period 1983-1987 using econometric models developed by DRI. (It is not clear why these models could not be used to estimate the foreign exchange losses associated with external shocks.) Motivated by relatively gloomy projections, Enders and Mattione proceed to consider three alternative policies: an investment-led recovery, a restructuring of external "debt, and an export-led recovery. An investment-led recovery, which consists of shifting resources from consumption to investment, is found to reduce real income and to increase external debt. This result is not really surprising since the resource shift is modeled as a 0.5 percent reduction in the intercept of the consumption function and a 0.5 percent increase in the intercept of the investment function. To the extent that the absolute value of the intercept of the consumption function exceeds that of the investment function, one should expect a net adverse impact on the economy due to a fall in aggregate demand and not to resource reallocation. External debt increases because of the financing of the foreign component of investment. A restructuring of external debt (with maturity of 22 years, 2 years of grace, and a 6 percent interest rate) would be beneficial to Argentina and Venezuela, but it would lower output for Latin American debtors as a whole. On the face of it, this is a very surprising result for which no explanation is given. (The authors also find that, even with relatively minor disruption costs, the decision to repudiate external debt is counterproductive.)
198
Book reviews
Given the inability of the previous two policies to reduce external indebtedness without inducing income losses, Enders and Mattione proceed to examine the advantages of an export-led recovery. This is the policy that they favour the most, and the rationale for it is well known in trade theory. By depreciating their currencies, Latin American countries expand their exports, an expansion that stimulates the rest of the economy and that generates foreign exchange revenues for debt servicing. Despite its appeal, the authors find that a sustained 4 percent devaluation of domestic currencies improves the external positions of Latin American debtors at the cost of real income losses. In view of these disappointing results, Enders and Mattione examine alternative export-led strategies. They find that, to be effective, the export-led recovery requires an increase in the exposure of banks to Latin America of 3.7 percent per year (p. 44). In other words, their findings suggest that the crisis of debt and growth can be resolved only if Latin American countries have enhanced access to foreign borrowing. Given that these results hinge on the relaxation of credit constraints, a deeper analysis of their nature earlier in their study would have added a good deal to it. Conclusion
On the whole, this study is a reasonably good first pass at the issues involved in the debt crisis of Latin America. It certainly identifies one of the key issues in this crisis - - namely, the tradeoff between growth and debt servicing. However, Enders and Mattione try to cover too much material in too little space. As a result, their analysis of the economic policy options open to Latin American countries falls short of the expectations it raises. Jaime Marquez 1 Federal Reserve Board, Washington, DC
Mark Holstrrm, Industry and Inequality: The Social Anthropology of Indian Labour (Cambridge University Press, Cambridge, 1984) pp. 342, £27.50. Over the past fifteen years or so empirical studies of the non-agricultural labour force in India, along with many other aspects of Indian social science, 1Economist. The viewsexpressedin this review are solelythe responsibilityof the author and should not be interpreted as reflectingthose of the Board of Governors of the Federal Reserve Systemor other membersof its staff.
Book reviews
Thomas O. Enders and Richard P. Mattione, Latin America: The Crisis of Debt and Growth (The Brookings Institution, Washington, DC, 1984) pp. viii + 66, $6.95. The central thesis of this study is that Latin American countries now face a tradeoff between promoting domestic growth and servicing their external debt: a decision to promote growth induces a debt crisis whereas a decision to service the external debt creates a crisis of growth. In view of this tradeoff, Enders and Mattione focus on the policies that Latin American countries might implement to avoid either crisis. To this end, they examine the causes that led to the Latin American debt crisis and the policies which can be implemented to resolve it. Causes of the debt crisis
According to Enders and Mattione, the debt crisis of 1982 was precipitated by external shocks, borrowers' inadequate domestic policies, and constraints in the supply of foreign credit. With few exceptions, external shocks reduced the availability of foreign exchange to buy imports and to service the debt. These shocks included increases in interest rates, higher oil prices, lower commodity prices, and slower growth in industrialized nations. (The estimation of these foreignexchange reductions is important for the analysis because they are used to evaluate domestic policy responses in Latin America.) However, Enders and Mattione assume that import and export volumes have a zero price elasticity, which is a very restrictive assumption. For example, the loss in foreign exchange reserves associated with an oil shock is estimated by applying the increase in oil prices (relative to a base period) to a given volume of oil imports. A similar procedure is applied to estimating the impact of the other external shocks. Inadequate domestic policy responses to the external shocks may have contributed to precipitating the debt crisis in Latin America. (Inadequate policy responses might have contributed to prolonging the debt crisis.) As Enders and Mattione indicate, the difficult question is how to determine whether these policy responses were inadequate. As suggested above, they argue that a policy response is inappropriate if the observed deterioration of the current account exceeds the estimated loss in foreign exchange associated with the external shocks (p. 18). I do not find their criterion for policy evaluation particularly useful. First, it assumes that the current account balance is the overriding objective of domestic policies. Although there are short periods of time when such an overriding objective might be justified, long run policy concerns, such as the tradeoff between equity and efficiency, reducing inequalities in the distri-
Book reviews
197
bution of income, or the creation of an infrastructure, are as important as the current account in the overall policy mix. Second, even if the current account w e r e the sole concern of policy-makers, there is no guarantee that the implementation of the 'correct' policy mix will be successful. Ex-post, the 'correct' mix might appear as ineffective because of unanticipated shocks. The third reason for the development of the debt crisis is the cutback in bank credit due to a shift in lenders' perception of borrowers' ability to service further increases in debt. The decline in oil prices and Mexico's suspension of payments on principal may have contributed to such a shift. Enders and Mattione, however, give relatively little attention to these credit constraints, which is regrettable in light of their findings, as we will see below. The conclusion drawn by Enders and Mattione is that the Latin American debt crisis was not so much due to external shocks or credit constraints, but rather the result of inadequate domestic policies. The logical implication of this conclusion is that the solution to this crisis lies in the implementation of domestic policies more conducive to promoting both growth and debtservicing capabilities, the analysis of which occupies the rest of their study. Solutions to the debt crisis
The analysis starts with the construction of a baseline case for the period 1983-1987 using econometric models developed by DRI. (It is not clear why these models could not be used to estimate the foreign exchange losses associated with external shocks.) Motivated by relatively gloomy projections, Enders and Mattione proceed to consider three alternative policies: an investment-led recovery, a restructuring of external "debt, and an export-led recovery. An investment-led recovery, which consists of shifting resources from consumption to investment, is found to reduce real income and to increase external debt. This result is not really surprising since the resource shift is modeled as a 0.5 percent reduction in the intercept of the consumption function and a 0.5 percent increase in the intercept of the investment function. To the extent that the absolute value of the intercept of the consumption function exceeds that of the investment function, one should expect a net adverse impact on the economy due to a fall in aggregate demand and not to resource reallocation. External debt increases because of the financing of the foreign component of investment. A restructuring of external debt (with maturity of 22 years, 2 years of grace, and a 6 percent interest rate) would be beneficial to Argentina and Venezuela, but it would lower output for Latin American debtors as a whole. On the face of it, this is a very surprising result for which no explanation is given. (The authors also find that, even with relatively minor disruption costs, the decision to repudiate external debt is counterproductive.)
198
Book reviews
Given the inability of the previous two policies to reduce external indebtedness without inducing income losses, Enders and Mattione proceed to examine the advantages of an export-led recovery. This is the policy that they favour the most, and the rationale for it is well known in trade theory. By depreciating their currencies, Latin American countries expand their exports, an expansion that stimulates the rest of the economy and that generates foreign exchange revenues for debt servicing. Despite its appeal, the authors find that a sustained 4 percent devaluation of domestic currencies improves the external positions of Latin American debtors at the cost of real income losses. In view of these disappointing results, Enders and Mattione examine alternative export-led strategies. They find that, to be effective, the export-led recovery requires an increase in the exposure of banks to Latin America of 3.7 percent per year (p. 44). In other words, their findings suggest that the crisis of debt and growth can be resolved only if Latin American countries have enhanced access to foreign borrowing. Given that these results hinge on the relaxation of credit constraints, a deeper analysis of their nature earlier in their study would have added a good deal to it. Conclusion
On the whole, this study is a reasonably good first pass at the issues involved in the debt crisis of Latin America. It certainly identifies one of the key issues in this crisis - - namely, the tradeoff between growth and debt servicing. However, Enders and Mattione try to cover too much material in too little space. As a result, their analysis of the economic policy options open to Latin American countries falls short of the expectations it raises. Jaime Marquez 1 Federal Reserve Board, Washington, DC
Mark Holstrrm, Industry and Inequality: The Social Anthropology of Indian Labour (Cambridge University Press, Cambridge, 1984) pp. 342, £27.50. Over the past fifteen years or so empirical studies of the non-agricultural labour force in India, along with many other aspects of Indian social science, 1Economist. The viewsexpressedin this review are solelythe responsibilityof the author and should not be interpreted as reflectingthose of the Board of Governors of the Federal Reserve Systemor other membersof its staff.