Hausmann, a Venezuelan, is planning a very different public presence after leaving the IDB. He’s deeply worried about events in his country, where he once was the minister of planning, and wants to speak about them publicly in ways that aren’t possible at one of the multilateral development banks.
| Hausmann: “We need to make sure that we are not part of the problem” | ||||||
Hausmann’s departure is clearly a major loss for the development community in Washington. “He was tremendously effective and basically put the research arm of the IDB on the map,” says Sebastian Edwards who served as chief economist of the Latin American and Caribbean Department at the World Bank from 1993 to 1996. “The IDB had been producing research, some of it high quality, all along, but it was not being noticed.”
Always provocative, Hausmann was known for looking into new areas and coming up with controversial solutions, but ones that obviously struck a chord in Latin American economics. “Ricardo had a great sense for identifying the issues that were relevant for the region,” said Liliana Rojas-Suarez, a former colleague. “He kept his ears open during all the time that he was there and translated the needs that he heard into the research operations of the IDB.”
Hausmann created a bit of a stir inside the IDB by taking on macroeconomic issues as well as broader questions relating to development. And he also had an impact on the other multilaterals, like the World Bank and the IMF, with his challenging views. “Because the IDB is seen as a less controversial institution in terms of macroeconomic issues,” says Claudio Loser, the IMF’s Director of the Western Hemisphere, “he could discuss policies more openly with individual countries and he was able to influence them in that way.”
Of course, there were critics. “In trying to defend the views that he adopted on a number of issues,” says Edwards, “he chose to emphasize the message in a broad way rather than the subtleties involved with the idea and the texture that it requires given the diversity of Latin America.”
What were your most important accomplishments as chief economist of the IDB?
Isaac Newton said, at the age of 85, that lifetime celibacy was his most important achievement. I don’t consider that to be in the top ten of his major contributions, but it goes to show that it is very hard to make self-assessments, even for someone like Newton.
In my case, it is hard to know what the judgement could be based on. One criteria might be our impact on the nature and quality of the policy debate. We started from scratch in February 1994 and set up the office of the chief economist. I hired the people. We defined the mission, decided on an approach to research and created an internal culture. We also targeted different audiences and developed products to reach them. We decided that we had three major audiences and that we had to link to each of them. These audiences were: the policymakers of the region, the academic community and the Bank itself. For the policymakers, we formed a network of central banks and Finance ministries that met twice a year. That gave us an eye and ear on what the region wanted and needed to discuss.
We also developed a product we called the encerrona. That is a brainstorming session with the president of a country and his cabinet on a Saturday, typically, an hour outside the capital city where we would make a presentation about the obstacles to development facing the country. And we have our annual economic and social progress report for policymakers.
You have been at the forefront in calling attention to the costs of pro-cyclical macroeconomic policies. Did policymakers get the message?
We started off in 1994 by focusing on the causes of a very high level of macroeconomic volatility in Latin America. We found that part of the problem was that policy outcomes were pro-cyclical, instead of anti-cyclical.
We argued that this was not caused by the intentions of policymakers. They are trapped into a pro-cyclical response to events. My best guess as to why Fiscal policy is pro-cyclical is that it has something to do with concerns over solvency. In bad times, people think that you are less able to repay loans and so your creditworthiness declines and you Find less Financing, although an anti-cyclical policy would have involved more borrowing. So, in bad times you are forced into a contractionary Fiscal policy because you lose access to Finance.
When I joined the Bank, the dominant paradigm assumed that macroeconomic problems were behind us. That was the atmosphere that reigned before the Mexican 1994 crisis. The problems uppermost in people’s minds were growth and poverty. Growth was seen as related to increased domestic savings and exports and also maybe education. The social aspect had to do with targeted government programmes.
We wrote a very critical piece on savings saying that it was the wrong policy focus. We argued that savings tend to follow growth and not the other way around. We showed that the main explanatory variable for the difference in savings between east Asia and Latin America was growth, not culture.
Moreover, we don’t really know much about how to affect savings. There was a lot of talk that savings could be increased by increasing public savings. People had estimates of the so-called “off-set coefficient” of Fiscal policy.
How much would the private savings decline if public savings increased?
We came up with a story that the off-set was very large except in periods of crisis. So, savings was not a good focus for a growth-oriented strategy and public savings was not the way to get there.
Moreover, we argued that saving was definitely not related to crises. That got most of the attention. Prominent economists at the time were saying that the Mexican crisis was caused by low domestic savings and that became the official position of Washington and the new Mexican government. We made the point that the savings issue was irrelevant, but it took the Asian crisis to show that high domestic savings was no guarantee against crisis.
We found that Fiscal performance had a lot to do with budget institutions. So, we put the emphasis not so much on preaching to governments about Fiscal policy, but on the appropriate constitutional and legal framework in which budgets should be approved and executed and contracts made for borrowing. We went further and looked into the issue of what is a responsible federal arrangement and the role of decentralization. Latin America was decentralizing and devolving power to local authorities and the question was what framework would assure that this trend would not lead to increased Fiscal problems.
I also think that the discussion of cyclicality led the IMF to consider adjustments of Fiscal targets to the cycle – if the recession worsened they would allow for a bigger deterioration of the Fiscal deficit.
But one area where there still has been little progress is that the World Bank and the IDB typically require countries to have counterpart funds. So, we say to a richer country if we send them a dollar for a project, they should put one dollar of their own into the project. Now, this creates a pro-cyclical bias into our own lending. In good times when the government has Fiscal resources, we disburse more. In bad times when they lack the Fiscal resources, we cut our disbursements. We are acting to exacerbate pro-cyclicality. This subject has been discussed internally at length, but still there has been very little action. We need to make sure that we are not part of the problem.
You were especially concerned about the health of banking systems as well as the quality of bank supervision and regulation. How would you characterize the progress in this area?
We looked into the causes of banking crises. There was a lot of talk that the answer was supervision and regulation. We argued that the Basle Standards were too lax for Latin America, given its high volatility. We also pointed out that credit booms were a problem in themselves and that they would probably escape the supervisor. Supervision is not like WYSIWYG – “What You See Is What You Get”. Instead, it’s what you don’t see that gets you.
We argued that it was not so much moral hazard that was creating weaknesses in credit markets. It was the lack of institutions that would assure debtors’ willingness to repay.
When there is a problem with willingness to repay, the market can become very thin and dangerous. If you try to charge a higher interest rate to compensate for the risk, then you increase the desire not to repay or you make it more difficult for borrowers actually to repay. So, it increases the overall risk and it makes the market smaller.
| Hausmann: “Most countries are now able to withstand big shocks without fireworks” | ||||||
We argued that the ability to attach collateral, to rapidly execute collateral, to use reputation through credit bureaus and sharing between creditors as well as group lending were important approaches to enhance the size and the security of the credit market. We also argued that Financial policies should be used to make banking less pro-cyclical by tightening the screws especially in good times. Banks should accumulate sufficient capital then so that they can take the hit in bad times. There has been a tremendous amount of progress in the countries and this is on everybody’s radar screen.
The fact that banking systems have become internationalized has been a major step forward. The idea was resisted at First. Certainly, no one here imagined that foreign banks would buy a very significant chunk of the domestic banking industry so quickly.
Right now, these are countries where much of the domestic banking system is in the hands of international banks. Not only do international banks have better ability to diversify risks, but they also have consolidated home country supervision. That means that they have to bring all their systems of risk management and accounting and disclosure and so on and that ratchets up quality. That may be part of the reason why we survived the Asian crisis so well in terms of the stability of the banking system. So, I’m very positive about Latin American banking. It’s an under-banked region and it’s definitely a sector where I can see a lot of growth going forward.
Why do you think that the case for a single currency (i.e., dollarization) in Latin America is so compelling?
I don’t know that dollarization is compelling for all of Latin America, but it is compelling for quite a few countries. I think that there is very little space for an independent monetary policy to do good, given that there is already a lot of de facto dollarization of liabilities. All of the foreign debt typically is in foreign currency and many of the domestic debts, whether public or private, are also in foreign currency. So, there is a lot of space for Financial fragility to make things go bad.
Dollarization of liabilities implies that there is a powerful balance sheet effect of monetary policy, since exchange rate depreciations in bad times tend to wipe out the equity of Firms and cause a credit crunch. Some of the crises we have seen in Latin America are examples. I think that those crises would have been avoided through monetary union. In the end, I think that globalization will require fewer currencies.
There is a big premium to Finding a good way to get to a world of fewer strong currencies, meaning currencies that you can use both domestically and internationally.
That raises a concern about trying to develop a Latin American currency. If the Latin American currency is not a currency in which you can borrow internationally and can do your international borrowing and trading, then it won’t do much good. If you’re asking the Uruguayan public that has 85% of their deposits in dollars and 15% of their deposits in Uruguayan pesos, to convert the 15% of their deposits into mercos, we would still have a lot of the problems that we have today.
I am encouraged by the recent research that shows a shared currency dramatically increasing trade in the long run. This debate is going to be settled in a few years when we see the impact of the euro on European trade. So, I think that there are also trade reasons to assume that dollarization would be wise.
I would say that there is no doubt in my mind that it would be to the great benefit of Mexico to dollarize. It would be to the great benefit of Central America and it would be to the great benefit of countries in Latin America that are heavily dollarized, namely: Peru, Bolivia, Uruguay and Argentina. It’s not critical for Chile because Chile can borrow long term in their domestic market and we are in fact helping them develop the ability to borrow internationally in their own currency. As you know, the World Bank has recently had an issue in indexed Chilean peso bonds. So, it’s not critical for them, but it is probably an attractive solution.
The other thing is that the payoff to adopting a common currency goes up as more countries become part of the currency zone. Anybody who dollarizes benefits from their neighbours dollarizing.
How do you reconcile your views about dollarization with the recent experience of Mexico and Brazil?
Mexico is now in a good position. The question is whether that is thanks to Mexico’s currency regime or in spite of its currency regime. I would argue that Mexico’s currency regime put the banking system in a very difficult situation over the last Five years and that the recovery of the banking system was slowed down by the nature of its monetary regime. So, this is a country that is growing in spite of the fact that it doesn’t have a banking system, in spite of the fact that bank credit has been declining and in spite of the fact that domestic interest rates have been incredibly volatile. Mexico’s success has a lot to do with Fiscal discipline and NAFTA, but not necessarily with the contribution generated by their monetary regime.
Second, I would remind you that convergence into the euro was done from Floating regimes. It was not from a narrower and narrower band. The narrow band essentially collapsed in 1992 and 1993 and then they more or less went from a Floating regime to monetary union. So, many of the things that have been happening in Mexico make it more viable and sustainable to attempt to dollarize now.
I still haven’t seen the success story in Brazil’s case. The devaluation caused the debt to GDP ratio to go from 30% to 50%. The country is projected to grow by something like 3.5%, after almost three years of no growth. You would expect a much brisker response of the economy. So, I would be cautious as to whether this system makes that much sense for Brazil.
In fact, if the Brazilian system were to be attacked it would be difficult to defend because any increase in interest rates would have big Fiscal implications that could have a deleterious effect on credibility and Fiscal solvency. An interest rate defense is not necessarily credible and what other defenses do they have? So, I would wait and see with respect to Brazil. The system has not yet been tested and consequently it’s too soon to tell. I would predict though that the current situation of relative competitiveness between Argentina and Brazil is not going to last forever. Remember that Floating exchange rates go both ways. People in Britain argue that Floating is the cause of their uncompetitive exchange rate.
Why hasn’t dollarization gained wider acceptance?
The debate has been a very theoretical, but now we have Ecuador. People argued that Ecuador would be the last country that should dollarize. Ecuador did not meet the traditional preconditions for dollarization – a strong Fiscal position and a strong banking system. Far from it. So, if Ecuador fails, it will just confirm the conventional wisdom, but if it can work in Ecuador, then it can work almost anywhere in Latin America. People are going to be watching Ecuador. There is serious talk of dollarization in Mexico and Central America, Argentina and elsewhere.
I would say that the First obstacle is political. Dollarization today is a unilateral decision taken by a country to adopt another country’s currency without any political understanding or support or agreement except at the very technical level. I think that for dollarization or monetary union to move forward there needs to be more of a political framework and that hasn’t been forthcoming.
Latin America hasn’t been a priority region for American foreign policy. The Clinton administration has not supported the Mack bill to rebate seigniorage. Also, we’re not in crisis. The real benefit of dollarizing is that it protects your system. Dollarization makes it less vulnerable to attack in bad situations and it allows you to achieve a much deeper Financial integration. Right now, the level of concern of a future attack has gone down significantly, but as situations deteriorate these things are discussed much more openly. It would be ideal if countries could design the institutions they want in good times and not wait for bad times.
You observed the 1994-95 Mexican crisis from a unique vantage point. What impact did that have on your views?
These institutions – the IDB, the IMF and the US Treasury – have trouble learning from their experience. The Mexican crisis was, for me, a learning experience. I would have imagined that the country probably needed some currency realignment, but I had not expected that the currency realignment would lead to an attack from the tesobonos which are that part of the debt that was protected from the devaluation. In fact, there was an issuance of tesobonos within days of the devaluation and the market bought it at 8% interest. So, the market didn’t see it happen even after the devaluation.
There was a lot of learning from that experience in terms of the importance of the structure of assets and the maturity of liabilities. The IFIs did ask themselves why they didn’t see it coming. They, in some cases, concluded that they saw it coming but didn’t communicate well with the countries. I would argue that this is essentially not true: we didn’t see it coming in the sense that the currency realignment would imply such a catastrophe.
People actually said at the time that postponing devaluations is bad. In fact, Brazil postponed its devaluation a lot and it didn’t turn out badly in that case. That means that the lessons from ’94 are probably not necessarily the right ones. The conventional wisdom would have trouble explaining both Brazil and Mexico. That is why I am so convinced now that we must look at the structure of assets and liabilities and understand the mismatches that are imbedded in those structures. This is also what made me change my views as to the usefulness of national currencies when they cannot be used to borrow abroad.
| Growth and poverty in Latin America were the key issues when Hausmann joined the IDB | ||||||
One important contribution of the Mexican crisis is that it got us out of the idea that after the First round of structural reforms we were essentially done on the macro side and that the rest would be more structural and social. One of the little Fights I had over the Mexican crisis is that I did not want international support to be conditioned. I thought that the attack against Mexico was essentially a liquidity crisis caused by the fact that people weren’t willing to renew their maturing debt because they didn’t see what resources Mexico had at its disposal to pay back.
If Mexico had the resources to pay back, then the debt would be renewed and the attack would cease. For political reasons, it was decided that they could not give Mexico unconditional support. Consequently, they tranched and conditioned the support. That caused the attack to continue as holders of tesobonos could not be sure that Mexico would have the resources to pay and in fact no tesobono debt was renewed. Private investors were taken out and the public monies Flowed in. That probably prolonged the crisis.
And it made me think that if crises were caused by concerns over liquidity, then support should not be conditioned. So, in the end tranching and conditioning the support to Mexico forced debt support actually to be disbursed. If the support had not been tranched and conditioned, maybe the support would not have been disbursed or needed. The situation might have stabilized earlier. The long period when the market was Finding out whether the country was going to turn around left interest rates extremely high and that significantly increased the cost of the banking crisis. That idea got into the thinking that led to the CCL.
How do you evaluate the recent proposal from the G7 finance ministers to improve the CCL?
It’s interesting that some of the points that they are changing now are ones that we originally proposed. One example is the idea of automaticity – that you qualify and are in that club you can draw immediately, if you are under attack. This was something that was resisted by the G7 a few years ago. There is obviously a concern about how to make sure that countries in the club maintain their standards. So, some mechanism, like the one proposed by the G7, for monitoring the country is important.
It also was clear that the IMF priced the product out of the market because there were no takers. So, the fact that they are reducing the price is also a move in the right direction. On the other hand, we initially thought that there could be private sector participation in the CCLs and that would multiply the resources available. As it stands, the CCL is a purely public sector initiative.
Latin America’s standing in terms of development has improved enormously, particularly since the Asian model has been discredited in so many quarters. How do you evaluate the state of the region?
The good news is that, unlike the situation in 1994 or in the 1980s, most countries now are able to withstand big shocks without Fireworks. The bad news is that we have not been able to integrate with the rest of the world in a way that is less volatile. The region has gone through rough times in ’98 and ’99 that were very costly in terms of large declines in output, deep recessions and higher unemployment.
It was difficult to imagine that the Asian crisis and the Russian crisis would have such large effects in the region. The terms of trade collapsed, capital inflows collapsed and the region was hit by a very, very bad deterioration in its access to capital markets. But it was impressive that, with very few exceptions, there were no banking crises, currency crises, inflationary crises or debt crises because we had strengthened our banking systems and our Fiscal systems. The principal exception was Ecuador where all of that happened. We also had deterioration in Venezuela, Colombia and Peru. I would say that short-term prospects for the rest of the region are pretty promising.
To avoid the volatility probably would require the region to become investment grade and to diversify its set of investors significantly. In the meantime, there are likely to be changes in the structure of Finance. The model in the future could be that most capital movements across borders will take place inside Firms. That probably is going to circumvent many of the market problems we have now. It seems to be happening in Europe. It’s too early to tell how significant that is going to be, but we seem to be moving in that direction. Also, the fact that the banking system has become internationalized has helped.But in the four problem cases, politics has been getting in the way of economic recovery.
In Peru, the main problem is institutionalizing democracy. In Colombia, they need to sort out the civil war as well as some inconsistencies that emerged from the constitutional reform of ’91. I am optimistic about Colombia’s recovery. I think that they are in a bad short-term situation, but they have the wherewithal to turn it around and, right now, they have a lot of support from the international community.
I think that the crisis in Ecuador should not be dismissed as something that only happens in weird cases and is not of general interest. What turned a bad situation into a catastrophe is something that is common to several Latin American countries. In particular, Ecuador had a weak Fiscal and Financial position with an increasingly dollarized system. When you have that, you can become vulnerable to self-fulfilling attacks.
People thought that banks were weak. So, they started to attack the banks and take money out. That weakened the currency. Weakening the currency implied that the dollar loans from those banks became less likely to be recovered because borrowers would have more trouble paying back dollar loans with the depreciating currency. That weakened the banks further and caused people to have even more reason to attack the banks. The depreciating currency reduced the likelihood of a government earning sucres to be able to pay up its dollar-denominated debt. That led to a further attack against government bonds. People were attacking all dollar liabilities and trying to Flee the currency and that led to a self-fulfilling catastrophe.
So, the highly dollarized countries – Argentina, Uruguay, Paraguay, Bolivia, Peru, Guatemala and Costa Rica – can be very dangerous places. Nevertheless, they are not in immediate danger. The year 2000 is going to be dramatically better than ’99 or ’98. The region is recovering quite nicely, in spite of the fact that the markets have not been particularly bullish.
How do you assess the economic prospects facing your country?
Venezuela is a very sad case. It faces the risk of enormous retardation of the entire process of development. Venezuela probably is, by any objective measure, the most poorly run country in the whole region in view of the fact that it doesn’t have the real physical or resource constraints that plague many of the other countries. But it still has made a mess out of things.
Venezuela has a huge current account surplus that has been used for capital Flight as the consequence of collapsing confidence in the rules of the game and the constitutional foundations of the country. Conditions are similar to those in Europe during the 1930s.
It has gone through 20 years of very bad economic outcomes. People became frustrated with the political system and decided to put a strongman in place of a democratic system. But the country’s poor performance had relatively little to do with the things that are being changed in the political system. It’s like a country that’s changing what ain’t broke and not changing what it needs to change. That’s a recipe for very dire prospects.
How do you assess Mexico’s prospects?
I think that Mexico has a glorious prospect. We shall see how the political system operates with more fragmented representation. The Mexican constitution defines a relatively weak presidency vis a vis congress, but that weakness has not been obvious over the last 70 years because the president has had control of congress and control of the party. In a situation where that changes, new interrelationships need to be developed.
That’s probably critical for President Fox – how to get things done through congress when he has minority representation. But Mexico has shown that opening to trade and integrating internationally accompanied by Fiscal discipline can have big payoffs and they are now reaping them.
Is Latin America improving so fast that the IMF, the World Bank and the IDB will become irrelevant?
There’s a high probability of that for some countries. We’re not important in Chile at all. We are likely to become less important in the more developed countries of Mexico, Argentina and Brazil. We are not playing any role in Venezuela. But I think that we still have a very long-run role in much of the rest of the region. Countries that become investment grade like Uruguay or El Salvador still want us to be involved because they think that we can add value to the design of specific projects that are very intensive in government technology. But I hope that a good chunk of the region will see us as less central than we were in the past and I think that would be a sign of success.
