Choosing sides in the trilemma: international financial cycles and structural change in developing economies

ABSTRACT

This paper analyzes the impact of international financial cycles on structural change in developing economies. It is argued that the impact of these cycles depends on the specific combination of macroeconomic and industrial policies adopted by the developing economy. The cases of Brazil and Argentina are contrasted with those of Korea and China. In the Asian economies, macroeconomic policy has been a complementary tool along with industrial policy to foster the diversification of production and capabilities. Inversely, in the case of the Latin American countries, long periods of real exchange rate (RER) appreciation, combined with the weaknesses (or absence) of industrial policies, contributed to the loss of capabilities and lagging behind.

KEYWORDS:

• Real exchange rate
• economic growth
• industrial policy

Acknowledgement

The authors are grateful to an anonymous referee and to the editors of this special issue for useful comments. We are also grateful to Martin Fernández, Andre Nassif, Antonio Neto, Pablo Lavarello and the participants of the ISIGrowth session in the 50 Anniversary Conference of the Science Policy Research Unit, held on the 7–9 September at the University of Sussex, Brighton, UK.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 The term industrial policy is used in this paper in its conventional meaning, which is a policy that reshapes incentives to favor certain types of activities or sectors over others.

2 The real exchange rate is defined as q = P* E/P, where P* is the international price level, P the domestic price level and E the price of the foreign currency (usually US dollars) in units of the domestic currency.

3 For a discussion of why Latin American policy makers show a strong preference for an appreciated RER see. Frieden (2015), Chapter 5.

4 As discussed in Palma (2012), causality goes from the capital account to the current account.

5 The opening of the capital account was a policy adopted by the end of 1976 and subsequently confirmed in the financial reform of June 1977 (see Dornbusch and de Pablo 1989, 37–56).

6 We would use this term here, due to its broader use in international debates, despite the argument by one of us (Ocampo 2017, chapter 4) that the broader term ‘capital account regulations' is more appropriate.

7 See Baltar (2015). Brazil fell into what has been labeled a ‘low RER x high interest rates trap' (Oreiro, Punzi, and Araujo 2012).

8 The composition of financial investments was heavily concentrated in short-term maturity assets (Kaltenbrunner and Paincieira 2015).

9 Noland (2013, 486) points out that ‘(M)odest financial-sector liberalizations that had been undertaken in the late 1960s were reversed in 1972'.

10 Noland (2017).

11 A Financial Supervisory Commission responsible for setting regulations and standards in the financial market was established in 1998.

12 Already in the early 2000s there was a debate in Korea about the costs of keeping which was already a massive amount of foreign reserves (see Ainzenman and Marion 2004).

13 Setser (2016) notes that China, Japan, Korea, Taiwan and Singapore rapidly recovered the levels of savings they had before the 2008 crisis.

14 See for instance Bell (2006) and Chang (2001).

15 Nevertheless, the Brazilian policy lacked the capacity to set targets, assess progress and penalize those firms that fell short of attaining the targets (in terms of productivity growth and competitiveness; cf. Moreira 1995).

16 Breznitz and Murphree (2014, 20) stress the role of experimentation and trial and error in policy-making, Noughton (2007, 100–102) points out the interplay between center and provinces in policy-making.

17 The classical work is Amsden (1989). See also Kim (1997, 2011) and Lee (2013).

18 Lim (2004, 150–51).

19 Engineering Industries comprise in the Standard International Trade Classification (SITC): Fabricated metal products, except machinery and equipment; Machinery and equipment; Transport equipment.

20 Lee and Lee (2019) reaches a similar conclusion running growth regressions using the NSI5 in the set of explanatory variables: ‘economies with successful growth experiences, such as South Korea, China, and Taiwan (…) mostly show upward sloping lines over time'. These authors also note that in economies with less successful growth experiences, such as Brazil, Mexico, Thailand, and South Africa, ‘the NIS5 index does not increase much in certain periods or even declines'.

Additional information

Funding

The ISI project received funding from Horizon 2020 Research and Innovation Framework Programme action under [grant agreement number 649186].