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IMPLICATIONS OF GLOBALIZATION FOR THE DEVELOPING ECONOMIES OF LATIN AMERICA AND THE CARIBBEAN
by Edmund M.Tavernier, Rutgers University

The notion that free trade and open markets create jobs and raise the standard of living is universally accepted by most economists (see Edwards). This notion is grounded in the belief that market allocations of resources are efficient and global economic integration fosters significant welfare improvements. In the case of the Latin American and Caribbean countries, these improvements may materialize because of the relatively abundant factor (unskilled labor) that is found in those countries.

Despite the potential benefits, the recent protests surrounding trade-related issues in world capitals such as Montreal, Seattle, Bangkok, Washington, D.C., and Genoa suggest that much more remains to be done to address the concerns of citizens throughout the world. These concerns include the economic issues of job losses to low-wage competition, and the environmental issues of deforestation and pollution, and other attendant issues related to the potential for economic instability when countries liberalize trade or pursue open policy trade regimes.

Few studies have examined the relationship between openness and such economic instability, and those that have, focus on the economic instability in developed countries (see Rodrik). Such focus ignores the reality that economic instability is sure to have a greater impact on developing countries for the following reasons.

First, the economies of those countries are generally small with a narrow range of primary products as their main exports (Gavin and Hausman).
Second, a casual observation of the countries in Latin America and the Caribbean suggests that although significant progress has been made to foster economic growth by liberalizing trade, the liberalization of the financial infrastructure has not been very successful.

The economic instability that may result from the above factors is compounded by other events that occur around the world. For example, an Inter-American Development Bank report indicates that the 1997 global financial crisis could have affected the Latin America and the Caribbean region in three possible ways.

The first method is through a contraction of direct bilateral trade as exports to Asian countries decrease because of recession in those countries and the increased competitiveness of local production.
The second method is through the potential displacement of Latin America and the Caribbean exports in third markets such as the Organization for Economic Co-operation and Development or the Latin America and the Caribbean regional market itself, where they compete with East Asian products that have become more price competitive.
A third transmission mechanism is through depressed commodity prices.

The above mechanisms are all related to trade openness in some fashion and are borne out to some degree by the increase in trade to GDP ratio (exports plus imports as a percentage of GDP). Between 1990 and 1999, the trade to GDP ratio in Latin America and the Caribbean increased from 19% to 35%. However, this increase is highly unbalanced. During that period the import to GDP ratio increased 108% while the export to GDP ratio increased by 57%.

Findings, Implications and Conclusions

The findings of this study support the view that trade openness may create economic instability through multiple sources (see Table). These sources include increased direct bilateral trade and investments, and export instability coupled with increased openness. The results also show that the current relationship between the trade balance and the debt structure serves to mitigate economic instability in the region. However, if the balance of trade does not improve there is a danger that over a period of time the region could find itself in a severe debt trap with an accelerating deterioration both in its net foreign asset position and its overall current account balance of payments, as net income paid abroad starts to explode. With the average growth rate of 1.32 % exceeded by interest rates, the exploding payments on the debt has emerged as one of the most challenging impediments to economic growth in the region (Bernal).

The economic instability alluded to above often leads to the anxiety that has been manifested in trade-related protests around the world. The findings should not be used as an argument against trade openness but a recognition that changes concomitant to global economic integration while spurring economic growth clearly has distributional consequences. Economists and policymakers because of their exclusive focus on trade openness and economic growth often ignore those consequences.

While trade openness is often beneficial to economic growth, other policies such domestic free markets and privatization, macro-economic stability, investments in education and health, and democratic institutions that sustain the rule of law are important as well (Business Week). Galbraith and Yotopoulus are concerned that while global economic integration and economic liberalization may be good for some nations, it does not appear to be good for small, developing countries. This concern stems from the absence of requisite institutions that are needed to facilitate the workings of the free market in those countries. In the absence of those institutions, trade openness can lead to divergent incomes and economic instability, increasing the difficulty of the policy options available to policymakers in the region.

First, while it is clear that economic growth may help to reduce income inequality, a broader economic vision that designs strategies that focus on bettering living standards is needed to counterbalance the distributional consequences described above.
Second, the wave of preferential trading arrangements in the region has increased economic integration, which, coupled with trade openness, has locked countries into the policy structure of others. Thus, global forces hinder the ability of Latin America and the Caribbean to control their national economic performance, and policy changes and shifts in the developed as well as developing countries, hold significant implications for economic growth in the region. Moreover, because economies with a larger endowment of the factors employed in innovation grow faster (Aghion and Howitt), the small open economies of Latin America and the Caribbean, particularly the Caribbean, are at a special disadvantage given their limited resources.
Third, capital mobility creates a potential source of economic instability and renders the tax basis foot-loose thereby reducing the ability of nations to conduct redistribution policies (Kurzer). However, the capacity for growth in Latin America and the Caribbean will depend on the countries' ability to attract foreign investment. Not only do these investments introduce foreign revenues into the local economy, but they also open access to foreign markets, make new technologies available and provide workers with training. Unfortunately, the small open economies of Latin America and the Caribbean have experienced difficulty in attracting investments that provide long-term, sustainable growth such as growth associated with manufacturing producer services.
Finally, although agriculture continues to play an important role in the welfare of the economies of Latin America and the Caribbean, the results indicate that as a percentage of GDP, the sector has no influence on economic instability in the region. This finding may reflect a diminished role for raw agricultural commodities as an export revenue earner, and a gradual transition to processed and semi-processed agricultural products. As this transition occurs, and despite the need for investments in that sector, whether national welfare improves in the region depends on the elasticity of substitution of the agricultural good. The ease with which factors of production (notably labor) can shift from production agriculture toward manufacturing and service industries will in the long-run help mitigate economic instability in the region and provide increasing opportunities for economic growth.

Table: Fixed Effects Analysis of the Influence of Trade Openness on Economic Instability in Latin America and the Caribbean

Note: Absolute values of t-statistics are in parenthesis. * = 99% significance; ** = 95% significance

References

Aghion, P. and P. Howitt. "A Model of Growth through Creative Destruction," Econometrica 60 (19992):323-51.
Bernal, R.L. "Influencing U.S. Policy Toward the Caribbean: A Post Cold War Strategy" in The Caribbean: New Dynamics in Trade and Political Economy. ed. A.T. Bryan, Transaction Publishers, 1995, pp. 209-230.
Business Week . Economic Viewpoint: Clueless on the Alps-or why I'm Down on Davos, February 14, 2000.
Edwards, S. "Openness, Productivity and Growth: What do we Really Know," Economic Journal 108 (1998):383-98.
Galbraith, J. K. and P. A. Yotopoulos. "Policy Roundtable," in Conference on Economic Inequality, The Jerome Levy Economics Institute of Bard College, November 1999.
Gavin, M. and R. Hausmann. Securing Stability and Growth in a Shock-Prone Region: The Policy Choices for Latin America, Inter-American Development Bank, Working Paper 315, 1996.
Inter-American Development Bank. Periodic Note: The International Financial Crisis: Implications for Latin American and Caribbean Trade, February 1999.
Kurzer, P. Business and Banking: Political Change and Economic Integration in Western Europe, Ithaca, N.Y., Cornell University Press, 1993.
Rodrik, D. Has Globalization Gone too Far, Institute for International Economics, Washington D.C., March 1997.

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