Publications by Author: Hausmann, Ricardo

This paper establishes a robust stylized fact: changes in the revealed comparative advantage of nations are governed by the pattern of relatedness of products at the global level. As countries change their export mix, there is a strong tendency to move towards related goods rather than to goods that are farther away. The pattern of relatedness of products is only very partially explained by similarity in broad factor or technological intensities, suggesting that the relevant determinants are much more product-specific. Moreover, the pattern of relatedness of products exhibits very strong heterogeneity: there are parts of this ‘product space’ that are dense while others are sparse. This implies that countries that are specialized in a dense part of the product space have an easier time at changing their revealed comparative advantage than countries that are specialized in more disconnected products.

This paper argues that current account statistics may provide a poor indication for the real evolution of a country’s net foreign assets. This may be due to a series of factors including the mismeasurement of FDI, unreported trade of insurance or liquidity services and debt relief. Because of these problems we suggest estimating net foreign assets by capitalizing the net investment income and then estimating the current account from the changes in this stock of foreign assets. We call dark matter the difference between our measure of net foreign assets and that portrayed by official statistics. We find dark matter to be important for many countries and that it relates to FDI flows, domestic volatility, and debt relief. We also find that, once dark matter is taken into account, global net asset positions appear to be relatively stable. In particular, the exports of dark matter of the US appear to be fairly steady and large enough to keep the US net asset position stable, casting doubts on the need for a major adjustment of the dollar or a large rebalancing of the global economy.

We study episodes where economic growth decelerates to negative rates. While the majority of these episodes are of short duration, a substantial fraction last for a longer period of time than can be explained as the result of business-cycle dynamics. The duration, depth and associated output loss of these episodes differs dramatically across regions. We investigate the factors associated with the entry of countries into these episodes as well as their duration. We find that while countries fall into crises for multiple reasons, including wars, export collapses, sudden stops and political transitions, most of these variables do not help predict the duration of crises episodes. In contrast, we find that a measure of the density of a country's export product space is significantly associated with lower crisis duration. We also find that unconditional and conditional hazard rates are decreasing in time, a fact that is consistent with either strong shocks to fundamentals or with models of poverty traps.

This paper clarifies how dark matter changes our assessment of the US external imbalance. Dark matter assets are defined as the capitalized value of the return privilege obtained by US assets. Because this return privilege has been steady over recent decades, it is likely to persist in the future or even to increase, as it becomes leveraged by an increasingly globalized world. Once this is included in future projections of US current accounts, the US external position looks much more balanced than depicted in official statistics.

This paper explores export performance in South Africa over the past 50 years,and concludes that a lagging process of structural transformation is part of the explanation for stagnant exports per capita. Slow structural transformation in South Africa is found to be a consequence of the peripheral nature of South Africa’s productive capabilities. We apply new tools to evaluate South Africa’s future prospects for structural transformation, as well as to explore the sectoral priorities of the DTI's draft industrial strategy. We then discuss policy conclusions, advocating an 'open-architecture' industrial policy where the methods applied herein are but one tool to screen private sector requests for sector-specific coordination and public goods.

Much of the recent debate on global economic imbalances has centred on Chinese exchange-rate policy. China has a balance of payments surplus. The People's Bank of China has been buying some $20bn a month in its attempt to keep the renminbi's parity with the US dollar stable.

American legislators are concerned about the advantage that a weak currency gives Chinese exporters. The US Treasury has given the Chinese six months to act on the currency and has appointed Olin Wethington as a special envoy to carry the message to Beijing. The Chinese authorities fear that a currency appreciation might worsen social and regional imbalances. An appreciation might slow job creation in manufacturing, worsening urban unemployment. It would lower the relative price of agricultural products, thus reducing rural income. Is there an alternative solution?

Excessive savings are at the root of the imbalance in China. In spite of China's impressive investment rate, its domestic savings rate is even higher and it attracts massive foreign direct investment. This abundance of savings is what is expressed in the external imbalance. A misallocation of resources occurs. Consumption is foregone, sacrificing the welfare of today's low-income generation not for the benefit of future, wealthier generations but in order to accumulate unneeded low-yielding foreign assets.

A reduction in China's savings rate could correct the imbalance. It would lead to faster growth and job creation and improve the welfare of the present generation. It would reduce the balance of payments surplus and stimulate faster global growth through increased exports to China. The increased internal demand would raise the rate of return of investment projects in China that cater to the domestic market. With proper macroeconomic management, even higher rates of investment and growth could be achieved.

But can China grow even faster than its current high rate? High growth becomes unsustainable when the economy becomes constrained by an insufficient supply of critical inputs. Usually, investment demand exceeds savings, bringing about a destabilising current account deficit. In other cases, high growth is checked by labour shortages and inadequate infrastructure. These shortages create inflationary pressures associated with currency depreciation, rising labour costs and bottlenecks.

In spite of China's rapid growth, these symptoms appear to be absent. The country exhibits an excess of savings over investment. Policymakers are concerned about unemployment rather than labour shortages. Infrastructure is expanding at an impressive pace. Inflation has remained low, with core inflation (excluding energy and food) almost nil. This suggests that the economy's speed limit may well be higher than the current growth rate.

An acceleration of growth would create pressures towards real appreciation, because the supply of importable goods is usually more elastic than that of non-tradables. In the context of faster job growth and incipient inflationary pressures, the Chinese authorities would be much more willing to allow an appreciation of the renminbi.

The reduction in savings could be engineered through either fiscal or monetary expansion. There are reasons not to choose the latter. First, an eventual credit expansion would be channelled through an already fragile banking system. Credit booms often end in tears. Second, a credit-induced expansion is likely to allocate the additional spending to those who can provide collateral. This would have the wrong distributive consequences both socially and regionally.

A fiscal solution has several advantages. First, it can be targeted to favour the regions and the social groups that have fallen behind. Second, it avoids the problem-ridden banking system. Third, it can address other developmental and social goals, such as housing, urban development and infrastructure. Moreover, the country can afford a fiscal expansion. Its debt level is barely 26 per cent of gross domestic product.

A fiscal solution is not without dangers. These include corruption, the risk of poorly designed programmes, allocations that are not compatible with sustainable development and the creation of entitlements that may be difficult to reverse.

As a response to the 2001 recession, the US Treasury allowed the fiscal deficit to widen by more than 5 percentage points of GDP. Public debt was put on a rising trend. When Mr Wethington meets the Chinese authorities, he might mention the US experience with expansionary fiscal policy. After all, what is good for the goose...

Unlike most cross–country growth analyses, we focus on turning points in growth performance. We look for instances of rapid acceleration in economic growth that are sustained for at least eight years and identify more than 80 such episodes since the 1950s. Growth accelerations tend to be correlated with increases in investment and trade, and with real exchange rate depreciations. Political–regime changes are statistically significant predictors of growth accelerations. External shocks tend to produce growth accelerations that eventually fizzle out, while economic reform is a statistically significant predictor of growth accelerations that are sustained. However, growth accelerations tend to be highly upredictable: the vast majority of growth accelerations are unrelated to standard determinants and most instances of economic reform do not produce growth accelerations.

In the presence of uncertainty about what a country can be good at producing, there can be great social value to discovering costs of domestic activities because such discoveries can be easily imitated. We develop a general–equilibrium framework for a small open economy to clarify the analytical and normative issues. We highlight two failures of the laissez–faire outcome: there is too little investment and entrepreneurship ex ante, and too much production diversification ex post. Optimal policy consists of counteracting these distortions: to encourage investments in the modern sector ex ante, but to rationalize production ex post. We provide some informal evidence on the building blocks of our model.

This paper investigates the design of an exchange rate policy for an economy where the domestic capital market is segmented from the global financial market, producers rely on credit to finance working capital needs, and the labor market is characterized by nominal contracts. We show that the choice of an exchange rate regime is intertwined with the financial structure — greater reliance on working capital to finance input needs, and greater segmentation of the domestic capital market increase the desirable exchange rate stability. This result follows from the observation that greater exchange rate stability is likely to reduce the real interest rate facing the producer, thereby increasing output. Hence, greater reliance on working capital increases the welfare gain attached to the lower interest rate associated with lower flexibility of the exchange rate, thereby increasing the desirability of a fixed exchange rate. Similarly, greater integration with the global capital market reduces the real interest rate benefits from exchange rate stability, increasing thereby the optimal flexibility of the exchange rate, and reducing the demand for international reserves.

This article discusses this "political economy" side of redesigning the international financial architecture. It draws heavily from our previous work (Fernández–Arias and Hausmann 2000a, 2000b). The next section reviews the problems of international financial markets. We subsequently assess their importance in light of the evidence and discuss for whom they are crucial. The last section reviews the solutions that are being proposed and discusses the distribution of their costs and benefits. Concluding remarks follow.

This paper discusses different views about what is wrong with the world, or as an economist would say, the principal distortions that are present. The intent is to clarify the logic behind the proposals for reforming the international financial architecture and provide a means of assessing them. (The actual assessment is performed in the companion paper "Getting it Right: What to Reform in International Financial Markets," Fernández–Arias and Hausmann, 2000.)

Countries that are classified as having floating exchange rate systems (or very wide bands) show strikingly different patterns of behavior. They hold very different levels of international reserves and allow very different volatilities in the movements of the exchange rate relative to the volatility that they tolerate either on the level of reserves or in interest rates. We document these differences and present a model that explains them as the optimal response of a Central Bank that attempts to minimize a standard loss function, in an environment in which firms are credit–constrained and incomplete markets limit their ability to avoid currency mismatches. This model suggests that the difference in the way countries float could be related to their differing levels of exchange rate pass–through and differences in their ability to avoid currency mismatches. We test these implications and find a very strong and robust relationship between the pattern of floating and the ability of a country to borrow internationally in its own currency. We find weaker and less robust evidence on the importance of pass–through to account for differences across countries with respect to their exchange rate/monetary management.

This paper asks whether the composition of capital flows is at all related to the likelihood of crises. The dominant view is quite straightforward. FDI involves a long–term commitment to a country and is "bolted down" in such a way that it cannot leave at the first sign of trouble. Hence, it is unlikely to be associated with crises for two reasons: first, because there must be something right about the country if capital is coming in as FDI; second, because even if there were problems, FDI does not have the explosive characteristics of other flows. As expressed by the World Bank (1999) "FDI also is less subject to capital reversals and contagion that affect other flows, since the presence of large, fixed, illiquid assets makes rapid disinvestment more difficult than the withdrawal of short–term bank lending or the sale of stock holdings."

This paper provides an overview and assessment of reform initiatives, both those currently on the table and those that are not but we think should be. The intent is to clarify the logic behind these proposals and assess them from a Latin American perspective. Our discussion is based on the extent to which reform initiatives alleviate the problems we identified in the companion paper "What?s Wrong with International Financial Markets," (Fernández–Arias and Hausmann, 1999). The overall conclusion is that the current approach to reforming the international financial architecture is not appropriate for the task and a paradigm shift is required.

In this paper we collect detailed information on the budget institutions of Latin American countries. We classify these institutions on a "hierarchical"/"collegial" scale, as a function of the existence of constraints on the deficit, and voting rules. We show that "hierarchical" and transparent procedures have been associated with more fiscal discipline in Latin America in the eighties and early nineties.

Working Paper 394, Office of the Chief Economist, Inter-American Development Bank, June 2006.

This paper attempts to assess the performance of alternative exchange rate regimes in Latin America relative to the benefits they are theoretically supposed to deliver. We will test empirically whether flexible systems allow for better cyclical management, more monetary autonomy and improved control of the real exchange rate. We find that flexible exchange regimes have not permitted a more stabilizing monetary policy but instead have tended to be more pro–cyclical. In addition, flexible regimes have resulted in higher real interest rates, smaller financial systems and greater sensitivity of domestic interest rates to movements in international rates. We also find that flexible regimes tend to promote wage indexation. We show that the revealed preference of Latin America is to allow very little exchange rate movement, even in periods of large real shocks such as 1998. We explain this preference as a consequence of de facto wage indexation and the high proportion of dollar–denominated financial liabilities. The paper then discusses the problems with fixed exchange rates and reviews the current interest in supra–national currencies, including full dollarization.

This paper asks how do the differences in income, fertility, participation and education come about. The central argument we develop is that the differences within and between countries are to a large extent related to a set of family choices that are strongly influenced by the potential returns to female education in the labor market. Differences in income, fertility, participation and human capital investment are not solely affected by personal characteristics. There are underlying conditions in the Latin American economies that are greater than individuals and families themselves and that shape family decisions. Some of them come from the functioning of labor markets, technological progress, factor endowments, and other factors at the country level. For instance, when the returns to education in the labor market are less differentiated, so that uneducated workers receive relative greater pay compared to educated workers, the differences in fertility, participation and the education of the new generations between poor and rich, are smaller. Therefore, what matters the most for these choices are the returns to unskilled labor. This has strong implications for income inequality.

In this paper we lay out the fiscal and financial policies that can help protect economies from the kind of global financial turbulence the world is now experiencing. Exchange rate policies are discussed in a separate paper.