In a recent article, I discussed the poor state of Latin American economies drawing on some rather obscure works by Raúl Prebisch, explicitly addressed to the disturbing role of capital flows on (primarized and open) Latin American economies. I find that the post-2008 cyclical trend of capital flows is an exacerbated version of what has been affecting Latin America since the days of Prebich .
Mainstream literature on capital flows to developing countries has shared two important commonalities since the 1990s. This literature, for example in the tradition of New Institutional Economics, tends to assume a beneficial effect of capital inflows, which leads to an improvement of peripheral institutions, whose deficiencies are ostensibly the main cause of economic turmoil and/or failure in attracting capital flows. In doing so, however, mainstream economists deliberately overlook the asymmetric characteristics of the international monetary system and the persisting hegemony of the US Dollar.
The enduring relevance of Prebisch’s insights
A careful review of Latin American economies over the past fifteen years leads me to an alternative interpretation. The figure below shows the sharp increase – approximately +50% – in the international reserves/GDP ratio of eight Latin American countries (LAC8) – Argentina; Brazil; Chile; Colombia; Mexico; Peru; Uruguay and Venezuela – in the 2003-2017 period. It is a remarkable piece of data, particularly if we consider that neither Argentina nor Venezuela have actively increased their reserves, for different reasons (debt restructuring and massive capital flight triggered by political instability, respectively). The increase in international reserves has been rather passive; engendered by prolonged surpluses in financial accounts due to capital flows towards Latin America.
Rather than triggering a sharp increase in investment (as predicted by mainstream economists), capital inflows were matched with the accumulation of reserves, which functioned as a typical macroprudential regulation.
Within the existing financial framework, international reserves could not be used to finance sovereign policies or even countercyclical fiscal policies in times of severe recession, as evidenced by Brazil in 2015-2016. Since the degree of financial openness remained high, international reserves acted as a ‘collateral’ for foreign investors (both financial and corporations), guaranteeing that the Latin American country receiving capital flows would not suffer financial turmoil, sudden stops and/or abrupt devaluations.
This empirical evidence makes it clear that the most used macroprudential regulation for Latin American countries still consists of purchasing bonds, assets, or currency of developed countries, implicitly assuming that they represent the safest possible investment. In other words, the asymmetric features of the international monetary system has not disappeared, but has deepened as a consequence of financialization. As if in a sort of ‘international division of financial circulation’, developed countries turned into providers of cheap global liquidity, which flows into the continent in search of speculative arbitrages. The stock of capital thus accumulated in Latin American central banks turned into a massive purchase of assets, bonds, and currency of developed countries.
A careful rereading of Prebisch shows that the current (and critical) state of Latin American economies is neither an unprecedented problem nor an unexpected consequence of the monetary turn of the Federal Reserve in the late 70s / early 80s. On the contrary, the post-2008 cyclical trend of capital flows is an exacerbated version of a recurrent problem that has been affecting Latin America since the gold standard era. In Prebisch’s days, capital outflow was strictly related to the colonial and post-colonial features of Latin American countries, which, in a sense, are still consequential to present days.
What can be done?
Given that changing capital flows represent a structural element of disturbance for primary commodity-dependent and financially-open economies, only a set of institutional reforms to be implemented at the sub-regional, regional and international level could offer a long lasting solution for Latin America.
In the short run – since primary commodity-dependent and underdeveloped economies cannot be modified ex-nihilo due to financial and exchange market volatility – such reforms would need to consist of bilateral payment systems to boost the use of national currencies in sub-regional and regional trade, together with a regional/sub-regional lender of last resort of international reserve currencies (such as the unfinished Banco del Sur project). This would reduce Latin American dependence on the dollar and international financial flows, creating room for higher capital controls.
In the medium-run, both the increased international reserves and the lower financial volatility resulting from the reforms mentioned above, would allow a more resolute transformation of Latin American economies. In this sense, the most remarkable step forward for this group of countries still consists of planned industrialization, focused on the substitution of dollar-saving imports. Along these lines, it is possible to achieve regional self-financing, which results in lower political subordination. This idea played a pivotal role in Prebisch’s mature work, since the publication of the well-known Cepal’s Manifesto (Prebisch 1949). Despite controversies around Prebisch’s solution, a careful analysis of the current situation suggests that no meaningful advancement can be achieved if these problems do not occupy the center of the debate.
Rather than adopting western type solutions, Latin American countries would benefit from a profound transformation of the existing international, regional and sub-regional monetary institutions to reduce the hegemonic role of dollar, which still represents a much formidable obstacle to their growth.
Roberto Lampa is a Senior Researcher in Economics, CONICET, Buenos Aires, Argentina. Photo: Raúl Prebisch, by CEPAL.