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The Pacific Alliance (PA: Chile, Colombia, Peru and Mexico) is advancing an agenda of Financial Market Integration as a means to cushion the adverse effects associated with liquidity constraints. But such a move is likely to do more harm than good without careful consideration of the glaring productive asymmetries that exist among member states.
Perry and Auvert (2016) argue that the primary reason for Financial Integration in the Pacific Alliance is the scarcity of investible funds – they pose the following as key factors for the decline in capital flows to the region. First, growth has started to recover in developed countries while all growth projections are pessimistic for Latin America – this inevitably forces foreign investors to reposition their portfolios away from the region. Second, it is expected that US monetary policy will be "normalized", meaning that the Fed will soon raise interest rates. This expectation is a powerful force that redirects capital flows to the United States. Third, global uncertainty, which is compounded by BREXIT increases the appetite for "safer" assets, which are considered to be non-Latin American. Fourth, the substantial losses suffered by foreign owned banks (within the PA) since the Global Financial Crisis led to a decline in private banking and less competition in the financial sector – this worsens the credit crunch. Finally, Perry and Auvert (2016) note that the enormous increase in the global regulatory requirements for the financial sector (which includes regulation against Terrorism and Money Laundering) further tightens the finance constraint.
Financial Integration in the Pacific Alliance is a means to increase the much-needed financial intermediation across the region. As currently perceived, Capital Market Integration is expected to enhance efficiency as bank based financial institutions face competitive pressures from financial markets. Further, greater efficiency and competition are likely to improve the transmission channels of monetary policy in the PA countries. Fundamentally, Capital Market Integration is expected to be a boon for the PA.
To effectively manage the integration process, Perry and Auvert (2016) call for regulatory convergence. Specifically, tax harmonization, better corporate governance standards to attract foreign investors, harmonization of issuance, clearing, settlement and operational procedures to reduce transaction costs across jurisdictions, a common passport for financial administrators, brokers etc., and remote access for brokers and investors to the PA irrespective of their location. Additionally, the authors note that there is a deficit of political leadership since Central Bankers and Finance Ministers are notably absent in the process. They call for greater political interest to ensure that the longer-term objective of full harmonization and a Single Stock Exchange is achieved.
Europe's Teachable Moment
The European Monetary Union (EMU) is essentially the financial and economic integration of countries with different productive structures or capabilities and this is particularly detrimental for member states in the absence of a fiscal union like the United States. Constantine and Renz (2016), Constantine (Forthcoming) and Constantine (2016) explain that monetary integration of asymmetric productive structures in the Eurozone led to capital flows to the periphery or economies with relatively inferior productive structures. This allowed households in the Eurozone periphery to live beyond their means and served as the foundation for current account deficits and household indebtedness. The latter quickly turned into a fiscal crisis as governments were forced to bail out private enterprises and households to a lesser extent with the onslaught of the financial crisis.
But financial integration of economies with substantial productive asymmetries can be damaging for an additional reason – they worsen the productive gaps. Capital flows to the Eurozone periphery fuelled a housing bubble and boosted non-tradables like construction and other consumption activities at the expense of building productive and technological capabilities. Like Financial Integration in the PA, the EMU was expected to increase the flow of investible funds into growth enhancing projects but dissecting the Euro crisis tells a different story. Stockhammer, Constantine and Reissl (Forthcoming) and Stockhammer, Constantine and Reissl (2016), among others, call for a European Keynesian New Deal to mitigate the many design flaws of the Eurozone and this includes narrowing technological and productive gaps among member states.
A Cautionary Note
A cursory look at the PA suggests that deep financial integration is likely to create two worlds – a centre and a periphery. Mexico is the leader country within the group – its economic complexity ranking (an index that measures the production characteristics or technological sophistication of economic systems) has increased by 14 places over the past fifty years. In contrast to Peru, Chile and Colombia, Mexico exports high tech goods: computers, cars, delivery trucks and vehicle parts. Further, unlike its comparator countries, Mexico’s trade surplus has been growing robustly since 2009 – it is easily the most important source of savings in the PA. In recent years, Colombia and Peru’s external position have deteriorated into deficits and Chile’s trade surplus is narrowing.
The decline in the net saving positions of these economies is unsurprising – the commodity boom is over or the basis of their previous trade deficits has collapsed. Still, the most important factor that predicts divergence within the PA is the fact that the economic complexity ranking for Chile, Colombia and Peru have declined steadily over the past fifty years. Peru’s decline has been most dramatic: its ranking has been reduced by thirty-one places between 1964 and 2014! It follows that the PA has experienced a technological divergence over the past five decades and my contention is that capital market integration without policies to reduce the obvious technological asymmetries will entrench the trade imbalances that are emerging and deepen the technological divergence. The flip side of this story is the accumulation of debt in Chile, Colombia, and Peru but not for productive investments – it is almost a truism that the on-going technological deterioration in these economies is likely to attract capital to non-tradable economic activities.
This has been the story of the Eurozone periphery and even Perry and Auvert (2016) acknowledge the absence of Finance Ministers and Central Bankers from the Financial Integration process – surely this almost guarantees that no policy will be put in place to address the important asymmetries. What is needed is technological upgrading in the PA and both theory and historical evidence suggest that bank based finance is far superior to financial markets in this process. To borrow Mariana Mazzucato’s term, the PA needs patient finance and this is unlikely to be sourced in volatile financial markets – even if these markets are integrated.
Constantine, C. (Forthcoming). Competitiveness and Macroeconomic Imbalances in Eurozone Countries, In: Rajmund Mirdala and Rosaria Rita Canale (eds.), Special Issue: Economic Imbalances and Institutional Changes to the Euro and European Union, International Finance Review.
Constantine, C. (2016). New Theoretical Justifications for Industrial Policies — This paper is prepared for the European Association for Evolutionary Political Economy (EAEPE) Symposium 2016, The Role of Industrial Policy in European Re-Industrialization, in Krakow Poland.
Constantine, C. and Renz, J. (2016). Can LAC Learn from Europe’s Mistakes? Divergence in Regional Economic Integration. Vox LACEA – The Resource sharing platform of the Latin American and Caribbean Economic Association, 12th August.
Stockhammer, E., Constantine, C. and Reissl, S. (Forthcoming). Neoliberalism, Trade Imbalances and Economic Policy in the Eurozone Crisis, in Nova Economia.
Stockhammer, E., Constantine, C. and Reissl, S. (2016). Explaining the Euro Crisis: Current Account Imbalances, Credit Booms and Economic Policy in different Economic Paradigms – This paper is prepared for the conference to commemorate the 40 years of the Cambridge Journal of Economics, at the McGrath Centre, St Catharine’s College, Cambridge, on the 12-13 July.
Perry, G. and Auvert, D. (2016). Financial Integration in the Pacific Alliance. IDB, Inter-American Development Bank.