Chapter

Comments: Santiago Levy

Editor(s):
Ke-young Chu, Sanjeev Gupta, and Vito Tanzi
Published Date:
May 1999
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First of all, I thank the International Monetary Fund for the opportunity to be here this afternoon. I would like to take advantage of Stanley Fischer’s remarks this morning inviting us to have an open and critical discussion about equity and economic policy design. I would like to draw on Mexico’s experience and, more broadly, from Latin America’s experiences. I will make three points that I think are important for equity and economic policy, some of which might have some bearing on the recent crisis in Southeast Asia.

I begin by noting that Mexico’s economy has been in a process of reform for over ten years now, but if you measure the outcome in terms of equity or an improved distribution of income and reduced poverty, the results have not been as desired.

The first point I want to make is that in the design of economic policy, it is essential to have a proper regulatory environment, particularly in the financial sector. Mexico’s experience in the past few years has shown that the absence of a proper regulatory environment in terms of how financial risks are distributed, how the problems of moral hazard are solved, and how bankruptcy laws operate has important implications for equity.

You might think that this remark is a bit off the mark at this conference, but Mexico’s experience has shown that financial liberalization and the rapid opening to international capital markets, in the absence of a solid regulatory environment and the proper mechanisms for distributing risks and avoiding moral hazards, have led to situations in which a macroeconomic crisis immediately turns into banking crisis. And the banking crisis, in turn, requires major rescue efforts with serious implications for equity.

To give you an idea of the numbers, the banking crisis that erupted in Mexico in 1995 was due largely to an ill-conceived privatization effort, the absence of a proper regulatory environment, and a rapid opening to world capital markets. The rescue costs of that crisis are, in present value terms, about 13 percent of GDP. If you take an interest rate of, say, 10 percent, this implies that the annual fiscal cost of servicing this debt is about 1 percent of GDP.

This will quantitatively change the nature of Mexico’s budget, substantially reducing the room to accommodate other expenditures. The effects of the budgetary allocations to rescue the banking system are highly regressive, in the sense that since bank deposits are concentrated (a result of the concentration of income), the net benefits of the bank rescue are also very strongly concentrated.

When you compare the amount of money that the budget will channel to food subsidies and other poverty-relief programs vis-à-vis the fiscal costs of the banking rescue, the numbers are very uneven. This makes it very difficult politically to take other necessary steps, such as removing generalized food subsidies and improving the efficiency of social programs. In general, it is very hard to carry out major budgetary reforms when you are allocating around 1 percent of GDP to something that the public generally sees as rescuing banks instead of investing in infrastructure and human capital.

I think the lesson here is that efficiency and equity go hand in hand; a properly designed, solid regulatory environment for the financial sector that minimizes moral hazard and better distributes the risks brings not only a more efficient financial sector, but also brings budget allocation equity, because the costs of not doing it have been immensely high. (Of course, once in a banking crisis, the costs of a banking collapse would be higher to all than the costs of a bank rescue.)

The counterpoint to that, and it might be relevant for some Asian countries, is to think how governments should rescue weak banks, and the inherent equity implications. I cannot tell you how to do it, but I can tell you that the fiscal costs of not doing it properly can be very large indeed, and the equity implications very negative.

The second point that I want to make, again drawing on Mexico’s and Latin America’s experiences, has to do with what Fischer this morning called the “second-generation reforms,” having to do with, for example, strengthening the rule of law, strengthening competition policy, designing appropriate bankruptcy laws, and fighting monopolies.

With hindsight, second-generation reforms probably should have been first-generation reforms. Let me explain. If you look at the distribution of income in some Latin American countries, including Mexico, you will find that part of the income concentration at the top cannot really be explained by returns to innovation or to human capital accumulation, or even to physical capital accumulation. Instead, some of this concentration is a result of very substantial monopoly rents, drawn from situations—particularly in the non-traded sectors like transport, banking, or telecommunications—characterized by a high concentration of special permits and concessions that lead to exclusive rights or lack of competition.

This is, again, an area where efficiency and equity would go hand in hand. If, over the past ten years as we engaged in a process of trade liberalization, we had also moved in parallel to generate a system of competition policy and a stronger rule of law in these particular nontraded sectors, efficiency would have gained substantially. But generally, these actions would have given the government more political leeway to continue with economic reforms. In terms of economic policy design and equity, some of the political capital that was spent liberalizing the traded sector should have gone into strengthening competition policy and eliminating exclusive concessions and monopoly rights in the nontraded sector. The balance, with hindsight, would have been more efficiency and, at the same time, more equity.

Note that these nontraded sectors visibly affect people’s everyday lives: their electricity, phone, transportation, and savings and checking accounts. Having competition in these sectors is important, because people’s lives are affected positively if they see that the quality of service is improving. And then, you begin to produce a positive association between creating a market economy and consumers receiving direct benefits from such a market economy. In the absence of this process, people tend to associate the transition to a market economy and market-oriented reforms with having their everyday lives dominated by monopolies.

My third point is that we have to go beyond direct poverty alleviation. Again, Fischer mentioned that adjustment programs should be accompanied by minimum safety nets and, clearly, the IMF’s adjustment programs should be designed to maintain a country’s minimum standard of living. But I think the IMF must go beyond basic safety nets and push for more aggressive measures of income equality, where the sense of income equality is a relative concept as opposed to an absolute concept of a minimum safety net.

I think the IMF must—and this has been mentioned by many here today—invest heavily in human capital and activities that enhance people’s opportunities. How this is done will vary among countries. For example, in the next few years in many Latin American countries, it will not be feasible to increase the resources put into education, health, and other human capital investments substantially. Governments’ efforts in these areas will have to be qualitatively changed. For instance, over the past three and a half years, Mexico has increased social spending from about 52 cents to 58 cents of every peso. Any further increase in the next few years will be increasingly difficult to attain. Thus, we will need to deal with issues that were mentioned by Amartya Sen this morning having to do with the quality of delivery and the relative sense of power of those involved in these activities. We must make a major shift from supply-side to demand-side interventions in the provision of public services. This is not a technical point. It is about who makes the decisions on where I obtain my health service, where my children go to school, and, more generally, what options and responsibilities I have as a consumer and as a family.

Under government provision, it is difficult to change the power relationship between who provides and who receives services. Thus, and this is my third point, policymakers must go beyond the purely quantitative aspects of putting more fiscal resources into social spending, to efforts that induce much more competition in government provision of health, training, and educational services. These are complex issues because of the moral hazard and asymmetric information problems that sometimes characterize such markets, but necessary to confront if you want to improve results.

If the search for equity in policymaking leads away from simple income redistribution to a broader, multidimensional concept, power must be shifted to other levels of government and, more important, to consumers, by changing the relationship between those governing and those governed. These are very difficult policies to implement but I think that the lessons from the past years show that they are now inherent in economic policy design.

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