Adam Smith challenged the view that countries could increase welfare with mercantilism absolute advantage What is the connection between ISI and Trade in Latin America Resources were diverted from industries with comparative advantage to disadvantaged industries. Most countries in the world learned a lesson from the trade war of the 1930s and started liberalizing their economies, but Latin America did not. Why? Structuralism. According to the Heckscher-Ohlin model, what causes differences across countries in opportunity costs of producing goods factor abundance and factor intensity NAFTA was replaced with the US-canada-mexico agreement Bretton Woods' System (1944-1971) - linked foreign currencies to the USD - currencies kept within 1% of the xed exchange rate - dollar-pegged exchange rate Exchange controls aims to restrict acquisition of foreign currency La Decada Perdida (The lost Decade) is essentially a sovereign debt crisis. (Economic crisis suffered in LATM during the 1980s) Which of the following occurred in the 1980s and compromised the position of Latin American countries in the international markets Volcker shock government borrow money in international markets through: bond issuance and loans from multilateral institutions Why should we expect higher FDI investments in Latin America than high-income countries and why have there been scarce FDI investments MPK is higher in Latin America than high income countries, lower than it should be due to political instability and isi Which of the following plans played a fundamental role in helping Latin American countries escape the Lost Decade: The Brady plan, which emphasized debt forgiveness. How has capital own historically into the Latin America region? Mostly in the form of debt. Which of the following claims is incorrect? Uncontrolled capital ows are best for attracting investments and mitigating exchange-rate shocks. (True: have potential to produce them) An interesting fact about the Latin America region is that from 1990 to 2014, remittances as a share of the world total: Have grown, almost doubling Economists believe portfolio capital to be essential for the economic development of a country. Why? brings capital to credit constrained rms or gos and allows them to perform pro table investments What is the goal of the Inter-American Development Bank (IDB) provides loans, grants, and assistance for the economic development of LA According to the Lessons from the Monetary and Fiscal History of Latin America, which is correct US economic policies worsened the debt crisis in the 80s and the authors used a budget accounting framework to understand common experiences Bank multiplier is the multiple by which a change in the monetary base translates to a change in the money supply debt monetization consists in borrowing more money from the central bank to nance public spending the equation of exchange establishes that nominal expenditures are equal to the monetary base times the velocity of money according to the costs and bene ts of dollarization dollarization can provide short-term stability and help control in ation and is typically measured as a ratio of foreign deposits to total deposits Economists say that most stabilization plans in Brazil were unsuccessful because they were not able to stabilize in ation at low levels for long time periods According to income dynamics and inequality: the case of Mexico, which is correct transitions out of formal employment can be costly because there are long term wage penalties when returning to formal sector When looking at measures of poverty, which of the following is correct? the population share in relative poverty is much higher than that given by any of the two famous poverty lines Applied to wealth, what does the Gini coef cient measure? deviations in actual wealth distribution from perfect equality in wealth When looking at poverty and inequality data for Latin America, which of the fol- lowing is correct? Latin America is plagued by large economic inequality and substantial levels of poverty. Which of the following is true about the Gini coef cient of income in Latin America? the gini coef cient has declined since the 2000s and Latin America is one of the most unequal regions in the world and has little dispersion —————————————————————————— fi fl fi fi fi fi fi fl fi fl fl fi Effects of tariffs on prices, quantity and welfare quantity falls, consumers pay more and consumer less compared to free trade free trade vs. trade with tariffs trade with tariffs causes deadweight but also has government revenue Multilateral trade negotiations - Mechanism for liberalization - Minimal initial participation of LA countries due to structuralism and lack of coverage for ag products - developed disadvantaged industries and lost consumer welfare and government revenue Ex) NAFTA free trade agreements - agreement between countries to eliminate tariffs on substantially all trade within a reasonable period of time - all trade but ag products - 15 years EX) European Union regional trade agreements - allowed countries to obtain some of the gain from trade while still protecting industries from outside competition EX) Latin American Free Trade Agreement fi fi fi fi fi fl fi fi fi fi fl fi fl fi fi fl fi fi fl fi fi fi fi Most common 2 types of exchange rate systems xed and exible exchange rates ex) Ecuador is xed and Brazil has a exible exchange control; current and nancial account examples exchange controls are imposed by gov/monetary authority to buy/sell foreign currency of residents and to buy/sell local currency from non residents - current ex) ability to import/export - nancial ex) restricts capital from leaving the country on a large scale Explain how the government of a Latin American country with a dollar-pegged exchange rate should act to keep the exchange rate xed in the presence of commodity booms and busts. if there is a commodity boom the government will hoard foreign reserves of USD which will push the demand curve for USD to the right keeping the exchange rate stable. if there is a bust the gov will sell foreign reserves of USD to push the demand curve left Explain the concepts of, and fundamental differences between, debt and equity. Give one example of each type. debt is when an economic agent borrows principal x and must repay x plus interest in agreed-upon payments(t-bills, bonds) equity is ownership of assets that may have debts or other liabilities attached to them, owners do not have the right to xed payments (stocks) ———————————————————————— Absolute advantage A country has an absolute advantage in the production of a product when it is more ef cient than any other country at producing it. comparative advantage the ability to produce a good at a lower opportunity cost than another producer terms of trade ratio between a country's export prices and its import prices as a percentage trade policy, in terms of ISI - tariffs and quotas on imports of industrialized goods - arti cially low exchange rates scal and industrial policies, in terms of ISI - favorable treatment to MNCs - direct subsidies to rms in certain domestic industries - favorable lending to rms in certain industries -SOEs Mercantilism idea that countries could increase welfare by adding to their stocks of gold and silver ISI-Trade -resources were diverted from industries with comparative advantage to disadvantaged industries Heckscher-Ohlin Model mix of factor abundance and factor intensity explains a country's comparative advantage (LA should export commodities, import machinery) Stopler-Samuelson Theorem if there is perfect competition, contract returns to scale and equality in the number of factors and production, then a rise in relative price of one good leads to a rise in the real return of the factor that is used more and a decrease in return of the other Example of Stopler-Samuelson Mexico opens trade -> mining industry increases -> car industry shrinks -> wage increases and capital decreases T/F Free trade tends to maximize the welfare of society true Two effects of tariffs 1. quantity imported falls, domestic production increases 2. consumers pay higher prices and consumer less Transportation in Latin America -Acts like a tariff and is a big impediment to economic development -intra-latin america transportation is as high as transportation with the rest of the world Why are transportation costs high -types of goods being transported -terrible infrastructure -corruption -criminality mesquita Morelia et al (2008) inef cient infrastructure is part of the reason why transportation costs are higher than what they could be Quotas - more distorting than tariffs - no government revenue -revenue goes to foreign importers -when income and demand rise, domestic produces bene t but consumers and gov suffer Reasons for Protectionism (protecting a country's domestic industries from foreign competition by taxing imports) old: tradition of high levels of tariffs/quotas new: structuralism General Agreement on Tariffs and Trade (GATT) -prohibition of quotas -MFN (most-favored-nation) status for tariffs balance of payments detailed records of all money in ows and out ows of a country current account records international transactions (goods, services, investment income, unilateral transfers) nancial account records the different between holdings and foreign assets by domestic residents and of domestic assets held by foreign residents Balance of payments components - current and nancial Components of the current account trade balance = exports - imports. investment income = pro ts, interests and dividends on assets. Unilateral transfers = assistance and remittances from foreigners to domestic components of nancial account Direct investment, portfolio investment, reserve assets Financial Accounts in latin america -change in assets abroad are typically small -changes in foreign-owned assets are typically positive -of cial reserves in Latin America are typically larger than reserves abroad Flexible exchange rates exchange rates are determined by market conditions increases in demand of USD Latin America sells local currency and buys UDS (ex. Mexico buys us goods, t-bills, visits us) increases in supply of USD US sells USD to buy Latin American currency (ex. us buys la goods, invests, or visits la) shifts in demand of USD increases in demand shift curve right -changes in income (booming economics want to import more, depressed import less) -changes in relative prices (higher in ation in LA than US, makes US imports cheaper) fi fl fi fi fi fl fi fi fl fl fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fl fl fi fi fl fi fi fi fl fi t/f booms lead to currency depreciation (more imports and higher in ation) true shifts in supply of USD increases in supply shift the curve right -changes in income (if US is booming, us will import more from Mexico which demands more pesos and supplies more USD) -changes in relative prices (cheaper in ation in LA than US will make Mexico exports cheaper) xed exchange rates rates of exchange between local currency and foreign currencies are pegged against the value of one or more currencies Mechanics of xed exchange rates booms: government will hoard foreign reserves of USD. bust: government will sell USD to push demand curve left exchange controls controls imposed by gov and monetary authority to buy/sell foreign currency by residents and buy/sell local currency of non-residents -gov could decide what to import/export -holders of foreign exchange were obliged to sell it to the government at the exchange rate - more common on nancial account than current Volcker shock A decision taken by the US Federal Reserve chairman Paul Volcker to defeat stag ation by dramatically raising interest rates in order to bring in ation down. Brady Plan, 82-85 -debt-forgiveness in highly indebted developing countries -treated liquidity instead of solvency crisis -countries were increasing their debt Baker Plan, 85-88 - commercial banks and multilateral institutions would increase lending - indebted countries would reform scal and monetary policy Lost Decade -economic crisis in 1980s (sovereign debt crisis) -during 60s-70s countries were borrowing large amounts to push ISI policies effects of the Volcker shock and decreases in commodity prices -less available resources since revenues decreased -caused countries to devaluate currency which created in ation Debt economic agent borrows principal X and must repay X plus interest I, with payments at agreed dates Equity ownership of assets that may have debts or other liabilities Debt nancing 1. bond issuance 2. borrowing from commercial banks in developed countries 3. borrowing from other governments or multilateral institutions equity nancing the lender may also be an owner of the company that is being nanced -FDI -Portfolio capital Capital ows in Latin america -capital in the region is mostly in the form of debt -breaking the pattern of default episodes is crucial for the economic development of the region FDI in late 70s - 90s exceptionally low levels of FDI in middle income countries (<1%) -oil shocks -lost decade -politcal turmail FDI in 90s return of foreign investors to the region since economic performance and political landscape increased FDI peaked at 4.5% of GDP FDI late 90s to early 2000s and late 2000s drops in fdi due to world economy (early: nancial turmoil in Asia, dot com bubble) (late: Great Recession) portfolio capital money ows used to purchase nancial assets like stocks and bonds -highly volatile -positive trend why is portfolio capital essential for economic development - brings capital to credit-constrained rms and governments - allows rms to carry out pro table investments Of cial Development Assistance (ODA) assists in the long-run economic development of a country. 2 forms. 1. government to government 2. multilateral institutions ODA from multilateral institutions (IMF, IDB, world bank) -loans and grants fro speci c development projects -typically received in due to exemption circustances (natural disasters) ODA from government to government -typically applies restrictions on loans and grants -mostly from US Inter-American Development Bank (IDB) provides loans, grants, technical assistance for the economic development of Latin America -48 countries (22 non borrowing and 26 borrowing) Remittances (unilateral transfers) - ows of money back to the home country of workers who are employed in a foreign country - large increase in size (5% in 1990 to 9.5% in 2014) alternatives to nance current account de cits -devalue domestic currency -sell foreign reserves -borrow foreign exchange Debt Uses -borrow to nance productive investments -borrow for "non productive" activity like intervene in the foreign exchange market and support ISI policies International Monetary Fund (IMF) -correct current account de cits during default crisis - act as a lender of last resorts -provide borrowing when borrowing is suf ciently low or austerity measures cause high levels of borrowing Government Budget Constraint scal and monetary policy are interconnect (probably know math behind this) t/f post war Latin America had large government budget de cits true (there were not enough taxes to cover gov spending and the de cits were partly nanced by printing money) Counter cyclical scal policy - operating at potential GDP = run a balanced budget - operating above potential = run a surplus (rev > expend) - operating below potential = run a de cit (expend > rev) Fiscal policy until 1990s 70s - moderate de cit. 80s - large de cit. 90s - declining how to pay for expenditures 1. borrow money from nancial markets (domestic or foreign) 2. collect taxes 3. print money monetary base cash in the hands of the public and reserves of the banking system (should know math) Debt monetization government can borrow money from the central bank to nance public spending instead of selling bonds fl fi fl fl fi fi fl fl fl fi fl fi fl fi fi fl fl fl fi fl fi fl fi fi fi fl fl fi fl fi fl if money supply grows at Gm what happens to the price level Gm>0 - in ation. Gm=0 - price level is stable. Gm<0 - de ation Neutral money in the long run, changes in the money supply have no in uence on the real side of economy (Real GDP, employment) Types of Dollarization de facto - unof cial or partion. de jure - of cial or full Examples of Dollarization Panama 1904 Ecuador 2000 El Salvador 2001 Zimbabwe 2009 anchor currency foreign currency chosen by a particular country to stabilize its exchange rates. USD has been the dominant, global anchor currency b/c developing economies attempt to stabilize their exchange rates to the dollar Measures of Dollarization - ratio of foreign currency deposits to total deposits - ratio of foreign currency loans to total loans Pros of Dollarization - Safe assets for individuals (partial) - price stability - International trade (reduction in costs) - borrowing costs (decrease in the risk premium and interest rates) Cons of dollarization - pressure on the exchange rate (partial) - exposed to real and nancial shocks - constrained control over monetary policy Dollarization in Panama reason: legal tender. bene ts: trade and price stability dollarization in Ecuador background: high in ation and volatility. bene ts: no bank runs, debt restructuring, lower in ation. Fiscal responsibility laws Brazil Currencies - only plano real was successful at keeping in ation rates low for a long period - 6 different currencies in 8 years Brazil Government Budget Bank of Brazil -commercial bank and bank of the government. Conta de Moviemento -between Central bank and bank of Brazil Plano Cruzado (1986) Price Freezing -goal to stop in ation inertia. Outcome -in ation dropped for 3 months and rebounded Plano Color (1990) Controversial Monetary Policy -gov con scated deposits in transaction and savings accounts -not suf cient to control in ation Plano Color 2 (1991) Trade liberalization. Outcomes: in ation remained high, Brazil remained more open, new president Plano Real (1994) Fernando Henrique Cardoso implemented Real and was elected next year Fiscal and Monetary Policies of Plano Real Fiscal Austerity - expends cut, new taxes, privatization, scal reforms Monetary - limited issuance of new currency -high reserve rations (100% after 7/1/1994) Outcomes of Plano Real -In ation inertia was solved -in ation rates decreased to single-digit levels -macro stability reestablished Absolute poverty lack of the amount of money needed to meet basic thresholds of human existence poverty lines in latin america - 1/10 live on less than 2.5 USD/day - 1/4 live on less than 4 USD/day Relative poverty standards of living de ned by an individual country to measure number of citizens it considers to be poor Gini Coef cient measures deviations of the actual income distribution from perfect equality. Takes values between [0,1] 0 indicates perfect equality; 1 indicates perfect inequality, equation: (x% of the population owns x% of income) Lorenz Curve graphic depiction of the actual income distribution (x% of the population owns y% of income) Gini in Latin America Average is .46, lowest .4, highest .51 Import factors of poverty and inequality -historical roots -isi -business and labor regulations -educational inequality Business and Labor Regulations in terms of Poverty -small rms tend to enter informal sector -reduced competition -higher wages and job security in the formal sector Wages are increasing in educational attainment Education->Human Capital->Productivity->Wages Reducing poverty -economic growth -regulation of business and labor market -education investments, focus on primary education Lessons from the Monetary and Fiscal History of Latin America Poor monetary and scal policy has been root of most macroeconomics instability in Latin America ●Budget Accounting models are important to see how government policies lead to instability ●Over-regulation and under-regulation can both result in banking crises and subsequent in ation ●Large amounts of debt in denominated foreign currencies leave countries vulnerable The Evolution of the Earnings Distribution in a Volatile Economy After analysis, we nd that wages were stagnant from 1996-2001 ●Signi cant drop in wages and wage variance during 2001-02 recession ●Decrease in income inequality coincides with increase in minimum wage, wage setting mechanisms, collective bargaining During period of low in ation 1997-2001, wage changes were less frequent, majority of wage changes were wage decreases ●During period of high in ation 2007-2015, wage changes were more frequent, majority of changes were increases ●The distribution of regular wage changes became more symmetric during the high in ation period than during the low in ation period
