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From issue: Trafficking and Transnational Crime (Spring 2010)

Policy Updates

A snapshot of policy trends and successes in the region.

In this issue:

Stimulus Spending: What’s Next for Latin America

Luis Oganes

In the heat of the global recession, Latin American policymakers took unprecedented actions to break the downward spiral in aggregate demand. Beyond aggressively supporting financial markets, including interest-rate cuts and liquidity injection measures in some cases, many governments also pursued significant fiscal stimulus packages. Success in mitigating the crisis reflected a country’s overall fiscal preparedness. But now may be the time to tighten fiscal belts.

Together with the deterioration of public-sector finances, discretionary stimulus policies in 2008 pushed the overall fiscal balance of governments worldwide from an average deficit of 2.6 percent of GDP to a gap of almost 7 percent last year. Latin America was not an exception. One third of the region’s fiscal deficit increase—which widened from 0.6 percent of GDP in 2008 to 2.9 percent in 2009—can be attributed to the fiscal cost of discretionary measures.

But the degree to which countries could use fiscal policy to cushion the impact of the crisis varied. In general, commodity exporters like Brazil, Chile, Colombia, Mexico, and Peru pursued prudent policies in advance of the crisis, either saving part of the windfall from high commodity prices during the boom years or using it to reduce net external liabilities. This opened the door for either the adoption of counter-cyclical fiscal measures in Brazil, Chile, Mexico, and Peru, or, as in Colombia, the avoidance of big fiscal spending cuts to help contain the decline in aggregate demand.

Even so, there was a wide variety in the type and scale of measures. They included increases in public infrastructure spending (Mexico and Peru), transfers to vulnerable groups (Brazil, Chile, Mexico, and Peru), tax breaks for auto purchases (Brazil), and freezes on government-controlled prices (Mexico). The fiscal cost ranged from 1 percent to 3 percent of GDP, well below that of developed and other emerging economies. But off-budget initiatives—including the massive loans granted by Brazil’s state development bank that added up to 6 percent of GDP—did not represent an immediate fiscal cost.

The story was quite the opposite for those Latin American countries where high revenues during the preceding boom years were matched by even higher expenditure growth. At a time of collapsing commodity prices and shrinking external demand for goods and services, these policymakers could not pursue aggressive counter-cyclical policies and were forced to push the brakes on public spending. Many such countries—including commodity exporters like Argentina, Ecuador and Venezuela, and importers (including most of the Caribbean)—either experienced a deeper recession or are recovering at a slower pace.

It is fair to say that regional stimulus spending—in countries that could afford it—was quite effective in cushioning the effects of the global crisis. The Brazilian, Chilean and Peruvian economies, which deployed the largest stimulus packages, will grow at the fastest pace in 2010, above 5 percent.

How long can these countries maintain fiscal largesse? Strictly judging by the fiscal room to spend, the countries positioned to pursue aggressive counter-cyclical fiscal policies last year can keep spending and let their fiscal stance turn pro-cyclical. Brazil should be able to nearly double its primary fiscal surplus and meet this year’s 3.3-percent-of-GDP target without many expenditure cuts. Chile still has around $14 billion in its offshore copper fund after spending $8 billion last year, part of which will likely be used for reconstruction after February’s earthquake.

Peru’s central and regional governments have savings equivalent to 10 percent of GDP, which will facilitate its strategy of supporting growth by accelerating public investment. Overall, much short-term fiscal retrenchment is unlikely in these countries.

A more appropriate question is whether countries that can afford to maintain expansionary fiscal policies should keep doing so even after their economies emerge from recession. Pressure from markets and rating downgrades already prompted Mexico to tighten its fiscal stance, forcing it to approve tax hikes—implemented this year—in the middle of last year’s recession.

But markets may not put similar pressure on Brazil, Chile and Peru due to ample global liquidity and the fact that their fiscal accounts still look much better than those of many developed countries. Instead, the pressure to start removing fiscal stimuli may come from inflation, which is already starting to accelerate in Latin America—up 5.1 percent from December 2008 to December 2009 and up 6.3 percent year-on-year in March 2010. While increases in taxes and/or administered prices have been a key driver of higher headline inflation in most countries this year, inflation risks are rising due to the broadening recovery in domestic demand, the normalization in still-low food prices and the rebound in commodity prices.

Pressure to reduce public spending may also come from currency appreciation. This is already happening across Latin America due to higher commodity prices and is being exacerbated by governments forced to cover fiscal gaps with external financing. Currency appreciation also limits the policy options of central banks, which are forced to implement interest-rate hikes that seek to fight inflation and intervene in currency markets in order to prevent further appreciation.

Policymakers may eventually realize that if fiscal policy is not tightened, central banks would be forced to aggressively hike interest rates and do the dirty job of fighting inflation alone, which could trigger more currency appreciation and hurt export competitiveness and growth. In the end, something’s got to give.

Investment: The Middle East Comes to Latin America

Michael J. McGuinness and Manuel J. Orillac

China usually tops the list of new investors in Latin America—and with good reason. Roughly half of China’s $50 billion in overseas investments in 2008 went to the region. Between 2000 and 2008, Latin America-China trade—driven by Chinese interest in the region’s natural resources—grew tenfold to $142 billion.

But the attention focused on China has allowed another growing source of investment dollars in Latin America to go largely unnoticed: the Middle East.

Capital flows between the Middle East and Latin America are on the rise, paralleling the stepped-up diplomatic relations between the two regions. Like their Chinese counterparts, Middle Eastern investors are focused on securing access to raw materials such as iron, copper, agricultural land, and food crops. In 2008, total merchandise trade between the regions rose to $18.8 billion—more than triple the total in 2000—with $11.9 billion representing Middle East imports of Latin American goods.

Brazil is at the forefront of the ballooning Middle East merchandise trade, while at the same time, Brazilian companies are increasingly looking to the Middle East for capital. Trade between Brazil and all Arab countries (a larger group than just the Middle East) rose to $20.2 billion in 2008 (from $8 billion in 2004) with the United Arab Emirates (UAE) leading the way as Brazil’s major trading partner. In 2009, Abu Dhabi Investment Authority undertook construction of two towers in Rio de Janeiro, and the Emirates’ Aabar Investments invested $328 million in the initial public offering of Banco Santander of Brazil.

In a further sign of interest, Middle East-based trade organizations are registering in increasing numbers with Brazil’s Securities and Exchange Commission, a step that allows them to invest more easily in Brazilian public companies. In 2007, 12 new registrations were reported, compared to just one in 2001. The total number of registrants now stands at 26.

Middle Eastern investment in Brazil is largely driven by investor and government concerns about food scarcity at home. As a result of their arid climate, the region’s countries are currently forced to import 90 percent of their food supply. They have responded by purchasing large tracts of arable land throughout the developing world. Saudi Arabia, for example, recently announced the establishment of an $800 million company to support investment in overseas farmland. Saudi officials included Brazil as one of their target investment markets.

That’s not a surprise. Brazil’s regular rainfall and its abundance of solar energy provides a year-round growing season. And the fact that Brazil holds 13 percent of global freshwater reserves is a major attraction to the parched nations of the Middle East. Moreover, its agribusiness industry is efficient, modern and competitive, providing a lucrative margin for investment. Global investors are also attracted by the fact that Brazil imposes no export restrictions on commodities.

The Middle East is already a major importer of Brazilian agricultural products, but agribusiness between the two regions is poised for even greater trade volumes. Currently, the region ranks third among Brazil’s major markets, accounting for 10.6 percent of total exports, a marked increase from last year’s 8.4 percent. Brazilian participation in this year’s Gulfood fair—the Middle East’s premier food exhibition—was one of the largest among participating countries. Sales in 2010 are expected to exceed the previous year by 50 percent and to jump to $60 million by year end.

Iran is one of Brazil’s principal importers, with trade, largely as a result of food sales, doubling to $2 billion between 2003 and 2007. The relationship between Iran and Brazil is evidence of Brazil’s willingness to engage with even the most distant of Middle Eastern nations.

Investment activity in other countries in the Americas is also increasing. The United Arab Emirates committed $250 million to a joint venture with Cuba to transform the port of Mariel into a world-class transshipment center. The UAE is also looking to strengthen economic ties with Argentina. In the backdrop of booming trade between the two countries, which in 2008 posted a 92.3 percent increase from the previous year, a three-day business roundtable will be held in December 2010. And Venezuela has caught the attention of Iran, having engaged in a number of joint ventures, including crude oil production and car manufacturing.

Economic ties have been facilitated by developments such as direct flights between Dubai and São Paulo. In the UAE, a commercial center provides easy access to Latin American products, investments and marketing opportunities.

Heightened trade activity is also being driven by Middle Eastern investment funds’ partial refocus of investment strategies toward emerging markets. This is likely driven by a quest for alternative investment opportunities, but it also may be a reaction to a heightened scrutiny of foreign investment in Western countries and pressure for greater transparency. For example, the Kuwait Investment Authority cut its portfolio investment in Europe and the U.S. to less than 70 percent (from 90 percent) in 2008 and announced in 2010 that it is increasing investment in emerging markets to 9 percent (from 3 percent), focusing on countries with 8 percent to 10 percent growth. Dubai International Capital is also focusing its $13 billion fund on emerging markets, with Brazil positioned as a potential benefactor.

There is no doubt that China will continue as a key, if not dominant, investment player in Latin America. Yet this should not distract attention from the Middle East, where a rising wave of investment promises to spill across Latin America. But it cannot be predicted whether this wave will gain momentum or quickly recede.

Gulf countries are investing millions in advanced technology to improve domestic agricultural practices and to be able to provide food sources internally. This investment may eclipse the current focus on Latin America, but Middle Eastern countries will continue to enjoy surplus funds that will likely be directed to investment abroad. Even so, food source security will remain a priority, and Latin America, with its abundant land and willingness to engage with new partners, will remain a focus.

Overfishing: Managing North Atlantic Fisheries

Anne Hawkins

On North America’s northeastern coastline, fishing is a way of life. Entire communities in coastal New England states of the United States and in Canada’s Atlantic provinces depend on the fishing industry for their survival. In New England—stretching from Connecticut northward to Maine—686 vessels landed 76 million live-weight metric tons (mt) of cod, haddock, flounder, and other groundfish (a group of 20 stocks of bottom-dwelling fish) in 2008—earning an estimated $85 million.

But this ocean bounty has a long and complex history, and overfishing in recent decades has seriously depleted many historically significant stocks. To ensure the continued viability of both fish and fishermen, the U.S. and Canada are working together to find a balance between conservation and profit.

One example of transnational resource management began in 1998, with the establishment of the Canada-U.S. Transboundary Resource Assessment Committee and later, the Transboundary Management Guidance Committee (TMGC). The committee allows for non-binding guidance to be provided on fishery management as part of an informal bilateral agreement. Authorities in both governments recognized that only by working together could they address the problems associated with major declines in stock sizes in the 1970s and 1980s.

Both countries had much at stake in finding common ground. Fish don’t recognize borders, and the rich North Atlantic fishing grounds extend from the Georges Bank region of New England to beyond the coast of Newfoundland in Canada. Revenue in the jointly managed area totaled $42 million in 2008, and the catch of just three stocks brought in $8.6 million. That year 147 U.S. vessels made 1,273 trips, catching 501 mt of cod, 1,649 mt of haddock and 1,531 mt of yellowtail flounder. The Canadian fishery caught 1,529 mt of cod, 14,815 mt of haddock and 158 mt of yellowtail flounder.

The U.S. has legislative tools for rebuilding the fishery. The 1976 Magnuson-Stevens Fishery Conservation and Management Act (amended in 1996 and 2007), for example, requires that “overfished” stocks be placed under rebuilding plans to return to healthy levels within 10 years. The Canada-U.S. effort under the TMGC was designed to provide complementary coordination in this effort.

Under this system, representatives from each country meet annually to allocate catch limits for these stocks using a formula based on historical catch percentages and current resource distribution. The decade-old U.S.-Canada agreement—seen by both sides as an effective tool for optimizing harvests—has enabled each country to follow their respective management plans. But a major snag in 10 years of collaboration arose over 2010 catch levels for Georges Bank yellowtail flounder.

In 2009, the U.S. proposed a harvest level in accordance with its formal rebuilding plan for the stock, which under Magnuson could not be exceeded. Meanwhile, the Canadians, who were not restricted by the U.S. rebuilding plan, cited increases in stock size and low fishing levels as justification for a higher catch threshold. The two sides came to an impasse: U.S. laws offered no flexibility, and the Canadians would not agree to what they considered artificially low catch limits. Ultimately, each country unilaterally adopted limits, placing the advantages of joint management in peril.

This disagreement exhibits the challenges of a non-binding agreement in a complex regulatory environment. However, some binational fishing agreements do have the force of treaties: the U.S.-Canada International Pacific Halibut Commission (1923), which regulates halibut catch levels in western Canadian and U.S. waters, is a success and could serve as a model for future agreements. By law, Magnuson-Stevens has provisions that would permit other international agreements, including treaties, to create greater flexibility in rebuilding plans.

Another development complicating efforts to improve joint fishery management is an ongoing transition in the groundfish industry to a management system known as “sectors.” Here, self-organized groups of fishermen get absolute allocations of stocks. This is projected to change fishing behavior and other characteristics of the fleet. The monitoring of groundfish fleets at sea is also increasing and will provide for more accurate assessments of catch levels.

Across industries, international agreements must work within complex physical, social and regulatory environments to stay relevant. But an effective agreement is especially critical at a time of fishery management transition and overall economic hardship.

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