Defining Business Cycle to Monetary Policy Purposes

Monetary policymakers try to identify turning points in the economy. The important of detect turning points in business cycles is related primarily to the goal of detect on time critical developments on the output gap –actual GDP minus Potential GDP. An expansionary cycle phase increases the risk of upward price pressures given the level production in the economy above its potential. On the other hand, a recessionary environment, with a output below of potential level, causes less probabilities of high inflation, allowing the possibility to ease credit conditions to stimulate aggregate demand, to induce the economy to get in track to its potential level.

However, business cycle and its components (mainly: turning points), are unobservable in the short run by many reasons, mainly: lag of publishing the data, data revisions, measurement errors, fails in the design of the collecting of data ad hoc of the economic phenomena, and other methodology problems.

According to the according to the classical definition business cycle is:

"Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions and revivals which merge in the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic; in duration business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximately their own". (Burns and Mitchell, 1946, p. 3)

This definition justify why classically the business cycle is defined as two nevative variations of quarterly GDP. However, in United States, the NBER's Business Cycle Dating Committee employs other definition as the follow:

"A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and peak, the economy is in an expansion". (http://www.nber.org/cycles/dec2008.html).

This definition explicitly cite production, employment, income as key indicators. In fact labor market indicators was the main point to declare that recession in US started in December 2007:

“The committee views the payroll employment measure, which is based on a large survey of employers, as the most reliable comprehensive estimate of employment. This series reached a peak in December 2007 and has declined every month since then”. Even when “The product-side estimates fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3” (http://www.nber.org/cycles/dec2008.html)

We didn’t see a two consecutive decline on quarterly GDP as classical definition say. The criteria employs to judge the phases of the business cycles and turning points is discretional, according to the goals of the office, committee or analyst in charge. Labor market conditions is a indicator not necessarily coincident to the business cycle, has been usual “jobless recovery” phases throughout the world. However, given the human nature of economic activity, as an activity where we mostly gain from income by selling our work in a job, the NBER's Business Cycle Dating Committee put more emphasis on labor markets as their importance rather than its coincidence with the business cycle.

That is the reason why a central bank must carefully employ and design a different criteria to detect turning points and define economic phases, maybe a little bit more near to the classical definition of two consecutive of quarterly fall on GDP, a definition to infer timely about the output gap to take timely monetary actions. These means take employment as one important indicator but it would be not the most suitable indicator, as it does according to NBER committee, because it could not be adequately synchronized to the business cycle, sending miss-signs of the direction of the economy.

Mexican economy could face circumstances where the recovery gain momentum even when employment doesn’t show recovery (another cycle of jobless recovery as firms delay hiring process in early stages of economic recovery). That could affect the effective of monetary policy considering the lagged impact of monetary policy in the economy.

The Regional Banks in Mexico, an Opportunity to Explore

The old roles of banks are borrowing money from economic agents with money surplus and lend it to economic agents who need money; this is the fundamental formula. However, the operations of banks are based on other economic principles, as the follow four:

· Solve partially a selection adverse problem. Banks plays a key role because they are specialized on evaluation of borrowers’ risk and the risk assessments of money’s destination. These activities minimize the prices of credits by reducing asymmetric information between borrower and lender, making impersonal this kind of operations.

· Make possible risk diversification. By raising money from many sources and lending the money to many lenders, with many purposes, the banks allow reduce as much as possible business risks, leaving the system risk as low as it’s possible.

· Design financial products matching expectations of borrowers and lenders. By syndicating financial resources, banks provide resources to high scale products with adequate timing; it’s not easy find a unique investor whom borrow its money to the build a hotel with low interest rate, during 20 years. The banks solve this by raising money by many sources with different maturity.

However, there are always gaps to fill between supply and demand of financial resources; there are niches, and mainly, in developing countries as Mexico. There are not only financial intermediaries “too big to fail” (using a fashionable expression); but there are also banks “too big to fill all market niches”; that is the reason why credit unions and other “mini” banks are growing in Mexico. That is the reason, aside of regulations, incentives and other structural variables, that in United States work more than 8,000 banks. In this aspect is possible that Mexico’s economy is working with below of its potential financial services; losing a opportunity to promote economic development throughout the country. In 1978, Mexico had 134 financial intermediaries registered as Banks; currently, only 48 banks are working.

On the other hand, the demand for financial services to attend some niches in Mexico, had incentive the creation of Unions of Credit and other financial organizations. However, this kind of “mini” banks don’t enjoy the same facilities as big banks have, the same supervision, the level of access to other channels of financing, insurance against systematic risk, and they are not part of the inter-banking web of resources transferences. Those elevate all the kind of cost, increase risk, and reduce the ability of supervisors to see any risky development.

Banking system must find themselves the market niches to invest money and raise money. However, government agencies must be design careful the incentives toward the creation of regional banks to fill all the niches forgotten by the big banks.

The missed opportunity: 1994-95 Mexico’s Economic Crisis

Evaluate policies of the past is one of the daily economist’s activities. Now is time to rethink about what happened fifteen years ago during 1995-94 economic crisis in Mexico, and go further, what could had happened without that crisis?

Central Bank’s version of the causes of 1994-95 Recession:

The exchange rate regime, bands flotation, was adequate to promote low inflation, fostering economic growth given the changes in the economic structure, and gradually decrease of current account deficit. However, the strategy was abandoned by two shocks: a rise in interest rates in international markets and domestic political events that pull out foreign investment. Otherwise the current account deficit could be adjusted gradually without a sudden and sharp exchange rate adjustment (Summarized from 1994 annual report of Bank of Mexico).

But there were failures, mainly the explained implicitly in Bank of Mexico’s report, as follow:

"As a result (after the cited shocks that dried international reserves), in 19 December 1994 the Exchange Commission decided to abandon the exchange rate arrangements reported within the "El Pacto” Committee to move to a floating regime. The committee was a widespread opinion to the effect that before going to a flotation, it was desirable to try to stabilize the foreign exchange market by raising the roof of the banda of fluctuation. However, when this measure didn’t succeed, it was agreed to move to a floating regime with effect from December 22 [...], the Mexican makers suffered a depreciation of about 71 percent in 1994” (Bank of Mexico, Annual Report, 1994).

A problem of imperfect information without clear plan to try to avoid the main problem: the lack of financial resources in dollars. Causing a massive speculative attack against the Peso, resulting in the follow macroeconomic environment in 1995 relate to 1994:

Variable	1994	1995
GDP, annual variation	4.4	-6.2
Inflation, annual variation	6.9	34.9
Current account deficit, as percent of GDP	-6.4	-0.5
Exchange dollar rate, percent of appreciation	26.5	94.9
Exportations, annual percent variation	19.1	23.9

During the worst of the recession, exportations compensated the plummet of other economic activities, mainly those activities exposed to internal demand. The exportations led the recuperation during 1996-2000. Otherwise, in absent of any devaluation, maybe the sector could had been equally successful, the external demand was vigorous, even during the peak of peso’s value in 1994 when exports growth 19.1 percent, without pull out resources from other sectors. 1994 was a well-balanced year across off all economic activities, each activity grew: manufacture activity, 3.6 percent; construction, 6.4; energy, 7.7; commerce, 2.8; financial services, 5.2; communications and transport, 7.8 percent. 1993 mild recession was also well-balanced with low cyclical-price pressures.

However, after the crisis in 1996, that year was a recovery unbalanced year, the recovery came from exportations of manufacture goods that put the economy out of the recession. The bi-annual variation of GDP by economic activity in 1996 in relation to 1994 was as follow: manufacture activity grew 5.4 percent; energy, 6.9; transport and telecommunications, 2.7 percent; Construction fall, -15.9 percent; commerce, -11.5 percent; and financial service with a sluggish growth of 0.2 percent. An awful economic growth, even when the economy in general grew 5.1 percent in annualized terms that year; awful because its implications on the welfare of Mexicana population and continued some years later, in the period 1996-2000.

This unbalanced growth during 1996-2000 had deep implications in distribution income and asymmetric regional development.

• High inflation, as always does, affected the distribution of income across segments of population; mainly workers, given that wages typically have a lagged behavior behind prices, so real wages under high inflation always fall; during this period the average rate of prices growth was 17 percent, while wages grew 15 percent; behind prices and gains in productivity.

• Asymmetric development in incomes. During 1995-2000, the GDP in north border estates grew 42 percent, on the other hand no-border states grew 27 percent and three south border states, Chiapas, Campeche and Tabasco, grew 16 percent in five years. Those states more relate to internal markets (retail sales, home and infrastructure construction, and services –as education and health) with sectors highly depend on financial markets as retail, they kept a potential growth below north estates, creating high regional disparities; surely, there were more variables behind, but the recession was a key variable.

Certainly the exports helped the economy grew outstanding, however the vigorous growth in exportations was not entirely linked to peso’s depreciation; the most important factor was the NAFTA, the fiscal regime to exporters, and external demand. However, what the recession really did was what we know: Ruined the financial system cutting the opportunity of a well-balanced growth throughout economic sectors, regions and population. On the other hand, maybe the recession could also be responsible of other government positive initiatives as fiscal reform, financial system reform, and private pension reforms; but the causality is not clear.

In short, Salina’s administration played a key role in the evolution of the recession because its bet for exchange rate regime that didn´t work and that expose heavily to the financial system and the entire economy to a system risk: a exchange rate regime very vulnerable to any shocks. Another key variable was the soft financial regulations that begun in a irregular privatization process of bank entities; and the lack of a deep public debt market (it could be helpful had had a private pension system, for example, to deepen the financial market). However, Zedillo’s administration didn’t make a plan to face the real problem there; high current account deficit, risky profile of public debt, and international tight credit conditions.

The way how the economy would had responded without recession can be answered by further empirical research. As always this could be a possible exercise; there are many hypothesis to solve and stylized facts to describe, for example some exercises to do:

• Proof that NAFTA and gains in productivity were the main variables behind the exporter boom in Mexico, to support the argument that the economy would had done better even in the absent of any kind of depreciation; under an adequate transition between exchange rate regimes.

• Make a stress test ex post to financial intermediaries in Mexico to know if they could had managed better themselves under a satisfactory transition of exchange rate policy (with lower inflation and country risk premium in interest rates), and so if we would had seen better figures on internal credit.

• Make simulations on how could be respond the income distribution without high rates of inflation and with better balanced economic growth across economic sectors.

• Testing the degree of sensitivity of economic growth by regions to variables as financial development, domestic and international demand. This factor would had been important behind the regional divergence in wages, income, and development, through the period 1996-2002.

These exercises could be valuable because it must help us to clarify some economic events of the past, mainly recessive periods, and take into account what are the lessons we learned.

Bank of Mexico’s vision on 1994-95 and 2009 Economic Downturns

(complete english version soon)

The economic recession in the period 1994-95 was the most severe in the modern era of Mexico. The cause that started the recession was the sudden lack of liquidity to finance the external current account deficit which led to an abrupt change in the exchange rate regime from crawling bands to a floating exchange rate, causing a drop in GDP of 6.9 percent, a increase in prices by 51.9 percent and a rise in the dollar's exchange rate of 96 percent, among other consequences. The recession of 2009 is the most severe in twenty-first century, GDP contracted 8.2 percent in first quarter and the dollar appreciated 26 percent annually in May. This crisis is coming from abroad, affecting the Mexican economy through many channels: decline exports, tight credit conditions, and through affecting people expectations related to consumption and investment decisions.

To understand both recessions, have historical answers and pretend to get new research lines about business cycle in Mexico, is very important study the way how the central bank saw these periods. I share you a summary of anecdotic information released by the central bank in Annual Report 1994, and the inflation report, first quarter 2009. I offer a more wide vision on 1994-95 than 2009 contraction because we have more fresh information about the current recession.

Highlights on Bank of Mexico’s Annual report 1994:

Summary, 1994. The exchange rate regime, bands flotation, was adequate to promote low inflation, fostering economic growth in the context of changes in economic structure, and gradually decrease of current account deficit. However, the strategy was abandoned by two shocks: a rise in interest rates in international markets and domestic political events that drove them off foreign direct investment. Otherwise the current account deficit could be adjusted gradually without the need for a sudden and sharp exchange rate adjustment.

Synthesis:

“En 1994, […] eventos políticos y delictivos generaron un ambiente de gran incertidumbre que influyó adversamente en las expectativas de los agentes económicos del país y del exterior […] [L]a contracción de recursos financieros del exterior también jugó un papel muy importante en la determinación del desarrollo económico del país. Dicha contracción respondió, en buena medida, a los aumentos de las tasas de interés externas y a la recuperación económica de los países industrializados, que redundó en un aumento de su demanda de fondos prestables”.

“El déficit de la cuenta corriente de la balanza de pagos aumentó en 1994 […] el incremento del déficit […] es imputable […], a los siguientes factores: a la reactivación de la inversión privada como pública, y a una disminución del ahorro del sector público mayor que el aumento en el sector privado […] Con frecuencia se ha mencionado que el déficit de cuenta corriente y la apreciación del tipo de cambio real fueron las principales causantes de las devaluaciones de diciembre pasado. Esa tesis merece un análisis cuidadoso […] En la medida que la apreciación vaya acompañada de incrementos en la productividad de mano de obra, no se puede considerar que aquélla implique una pérdida de competitividad con el exterior”.

“[E]l nivel de reservas internacionales se mantuvo prácticamente estable en el período comprendido de finales de abril a mediados de noviembre de 1994. Este hecho es muy significativo; indica que sólo cuando se presentaron perturbaciones exógenas, el financiamiento de la cuenta corriente resultó insuficiente. Durante el resto del tiempo, los flujos netos de capital hacia México fueron de monto similar al déficit de cuenta corriente, por lo que la balanza de pagos global se mantuvo en equilibrio”.

“Sin embargo, nuevos acontecimientos desfavorables ocurridos a mediados de noviembre y a partir de la segunda decena de diciembre, produjeron una situación que a la postre fue imposible superar. Ello, en vista de la ocurrencia de los siguientes factores: a) agotamiento del margen para que el tipo de cambio pudiese ajustarse al alza dentro de la banda de flotación; b) sustancial reducción de las reservas internacionales; y c) tasas de interés reales a niveles que implicaban graves dificultades tanto para los intermediaros financieros como para los deudores. Estos factores, aunados a una renovada volatilidad en los mercados internacionales, […] provocaron un ataque especulativo de gran magnitud en contra de la moneda nacional. Un ataque que ya no pudo ser detenido mediante las medidas que hasta entonces habían sido eficaces”.

“En consecuencia, el 19 Diciembre de 1994 la Comisión de Cambios acordó abandonar el régimen cambiario comunicado en el seno del “Pacto” la decisión de pasar a un régimen de flotación. En dicho foro se encontró una opinión muy extendida en el sentido de que antes de ir a una flotación, era conveniente intentar la estabilización del mercado cambiario mediante la elevación del techo de la banda. Sin embargo, al no tener éxito esta medida, se acordó pasar a un régimen de flotación con efectos a partir del 22 de diciembre […] tomando como referencia el tipo de cambio intercambiario, el peos mexicano sufrió una depreciación de aproximadamente 71 por ciento en 1994”.

“Durante períodos prolongados el tipo de cambio tendió a mantenerse cerca del piso de la banda y las reservas llegaron el 15 de Febrero de 1994 a un máximo de 29,228 millones de dólares. […] En las condiciones descritas, el incremento del desliz parecía innecesario y de aprobarse hubiese resultado contraproducente. [Se] había comprobado que la conducta de los agentes económicos estaban influidas por la trayectoria anunciada del desliz del techo de la banda. Lo mismo puede decirse de los salarios. […] Como es obvio, esto habría resultado en costoso más elevados y más inflación. […] Los proponentes de las devaluaciones no siempre advierten que la eficacia de éstas para mejorar la competitividad de un país está condicionada a que los sueldos y salarios no suban, o, en todo caso, a que asciendan en menor proporción que el tipo de cambio. De no satisfacerse esta condición, las devaluaciones no tienes más consecuencia que provocar mayor inflación y el agravamiento de los problemas que ésta produce”.

“El régimen cambiario […] era congruente con una estrategia de mediano plazo tendiente a alcanzar bajos niveles de inflación, crecimiento económico rápido y sostenible, así como una reducción gradual del déficit de cuenta corriente de la balanza de pagos”.

Highlights on Bank of Mexico’s inflation report, first quarter 1994:

“La evolución de la actividad económica […]se enmarcó en un contexto […] caracterizado […] por un creciente deterioro en los niveles de demanda y […]por condiciones […] adversas de acceso al financiamiento externo en los mercados de capitales internacionales. Este entorno […]se vio reflejado en […] las cifras de demanda y de actividad productiva domésticas, las cuales sugieren que, en el trimestre que se reporta, la economía mexicana registró una caída considerable en sus niveles de actividad. Por un lado, la evolución de las exportaciones de bienes y servicios muestra que el deterioro de la demanda externa persistió […]. Por otro, se observó’ una transmisión más profunda y generalizada del choque externo a los niveles de gasto doméstico”.

The Geography of the Recession and the Imperfection of Short-Term Economic Analysis

Mexico lost 3.4 percent of its formal jobs in annualized rate in April 2009. However, employment had not a uniform behavior; Chihuahua, lost 14.0 percent; Baja California, 9.4 percent and Tamaulipas, 8.3 percent; all north border states. However, other states created jobs; Campeche, 4.1 percent; Chiapas, 4.0; Oaxaca, 3.7; and Veracruz, 3.7; all of them southern states.

The main reason behind this irregular behavior is not its geography per se but their economic structure (with variable geography being important). Remember, the state’s economic structure defines its business cycle responsiveness and how it reacts to economic shocks. In the present recession with a international shocks affecting through two transmission channels: fall on exportations and tight conditions on financial markets.

Let’s take a look over the four larger states with high employment swings to describe its structure and how they have reacted recently in the face of the current economic downturn, particularly: Chihuahua, Baja California, Veracruz and Campeche.

Contribution to its GDP by three sector: manufacture, mining and commerce

(Percent)

	Manufacture	Mining	Commercial Activity
Chihuahua	18.6	0.8	34.1
Baja California	18.9	0.1	25.3
Veracruz	16.0	1.1	19.6
Campeche	1.3	42.1	17.3

Source: INEGI at: www.inegi.org.mx

Clearly the exposition to the recession is larger in Chihuahua and Baja California because they have more participation in two sectors highly expose to international shocks; manufacture and commerce. The industry of boarders states is deeply concentrated in the production to consumer goods for exportation, therefore a suddenly fall in US consumption led a fall in manufacturers products (during May exportations fall 35 percent); and both states have higher participation in commercial activity, very sensible to border commerce, wages and credit conditions.

On the other hand, Veracruz and Campeche have lower participation in commercial activity and manufacture production. The economy of Campeche is largely determinate by mining, particularly oil extraction, a sector with sources of volatility determinate, in order, by: natural endowment, financial health in public budget, and oil prices. So this time with relatively stable oil production andincrease spending on oil extraction; this sector keep its peace, creating jobs and compensating the fall on other sectors.

In the case of Veracruz ,which despite having a smaller commercial sector it has industrial sector almost similar in size to the northern states. However, its industrial sector is very different from the northern states; Northern states produce more than 50 percent on higher value added goods such as computer equipment and other electronic goods, while Veracruz produces processed food by 50 percent; this industry traditionally more affected by supply disruptions than demand shocks.

These results brought some reflections about the short term economic analysis. Recently has been attractive to declare the supremacy of some ways of growth over others ways. Under the criteria of recent economic performance, France in Europe and China in Asia, are the winners; both countries are heavily regulates, with strong presence of the government, and both economies show better figures than US, Canada and Japan for instance . The losers are Mexico and Germany, respectively, countries highly dependent on exportations, whose have been working toward trade openness, less regulation, more competition, less unions, more flexibility, fiscal discipline, etc.

Now, is better be Veracruz than Aguascalientes, better be Oaxaca than Baja California. Have strong government than a weak one. Now government spends better than privates, and more important, government spends better private resources than private themselves. This is supported by short term economic analysis that enjoy Keynesians (“In the long run we are all dead”).

This discussion is very important under assumption that shocks with permanent effect of economic growth. This time this assumption is stronger than ever because lawmakers, policymakers, and all kid of adviser are questioning the “old way” of doing economics around the world and they are doing something about it. Fiscal deficits are in fashion. Industrial policy are more active than the previous decades; saving sectors and companies “engulfed” in flames. Increasing public debt –future tax - and forgetting the “old economic agenda”: fiscal discipline, quality education with educational vouchers, technological innovation with private resources through financial instruments as investment risk funds.

It’s very important the presentation of conjuncture reports as Bank of Mexico does. However, this report and other of this class, should be taken carefully and considering its main goal, in the case of Bank of Mexico, justify the monetary policy decisions, the economic context of these decisions, explains the causes of the trajectory of prices in the economy, and as result of its commitment in terms of accountability and as an operational objective through its effects on inflation expectations. It shouldn’t seen as tool to persuade those involved in modify the incentives in the economy, particularly those incentives created to affect negatively the economic performance as strong government presence on the economy, industrial policy or rules in executive pay.

Micro bubbles

Avocado and agave production have shown strong variations in recent years. The production of agave in Jalisco and others nearby states grew heavily by strong demand to satisfy the demand from tequila industry, during exporter boom of tequila that began in the late 1990s. On the other hand, avocado production has also registered a significant increase due strong external demand by the opening of United States market, bringing up prices. In both cases, during the boom, the value of production was similar or larger than the amount of remittances in Jalisco and Michoacán, states with highly dependent on remittances.

In the past ten years, both activities shown more unusual output patterns than other activities. The highest annual value increased of the agave was 388 percent in 2000 and 115 percent in the case of avocado in 1999. But they have also had negative variations, in 2000 the value of avocado production plummeted 43 percent, while during 2004-2006 the production value of agave decreased of 64 percent. The results had catastrophic economic effects on these regions. These are economies of “boom and burst", expression over-employed recently by Barack Obama to support his policies.

High prices during boom of agave drove farmers to invest heavily in the activity and more important, attracted investors from other places looking road toward prosperity. The media revenue per agave farmer in  Jalisco in 2000, during the boom, was around 900,000 dollars, 110 times the GDP per capita, over an investment that rarely reached 40,000 dollars per farmer. In fact, the revenue over the pre-boom value of the land, was forty times higher. This was the root of the overreaction, it drove frenetically to invest, to cultivate thousands of plots more. During 1999-2003, the agave surface grow 500 percent, it could be more but there were some limits as the lack of financial channels to support the investments and other kind of financial constraints (a old problem in this sector), the euphoria was there. Now the expected revenues don’t reach 70,000 dollars per farmer, a tiny fraction from the figure expected and far of total costs.

On the other hand, we are seeing the evolution of another agriculture mini-bubble, the avocado fever. High prices by the openness of trade to United States created the incentives to increase investments in this product. The annual revenue per farmer grew to around 134,000 dollars in 2007 with total costs of production below 40,000 of dollars. The avocado is mainly cultivated in Michoacán; however, high expected incomes spread its production to others states as Jalisco and Guerrero, between 2000 and 2007 the production grew 240.1 and 140.9, respectively. The risk of over-production is on the table, the next three years thousands of hectares will be harvested; we wish that the growing demand keep its peace to support the high levels of supply, however that is highly unforeseeable.

Agave and avocado crops share a peculiarity: it takes years before beginning their harvests, which it means that the revenues take years to become income after the initial investment. So the expected revenue by the farmer is very uncertain and farmers should form expectations of how prices might move on in a span of time that often reach 8 years. Even in hotel business services, an activity that requires patience to amortize the investment, presents less challengers because it begins to generate a cash flow once it starts operations.

Why are these facts, bubbles?. Paraphrasing The New Palgrave Dictionary of Economics and making an ad hoc definition,  because Bubbles can be defined as poor based expectative about expected revenues and exceeding overwhelming historical revenues. That was exactly what happened,  investors believed that they could get the same level of contemporaneous revenues in the next years, even when the situation was unique and temporal (simultaneously, market shocks from supply and demand side). Destroying wealth because land prices and rents of plots, inputs, technical advice, grew outstanding; and affected other products because them were displaced by the agave to produce tequila, mainly the production of corn.

 

It could be possible to limit the occurrence of this kind of bubbles, if we promote a public good very important to investors: information. Providing professional advice, publishing timely reports  of agriculture outlook (including recent trends, risk balances and prices expectations), and let fail to promote a better bias toward risk. However, there are some incentives behind this behavior that could be promoting their occurrence; the intervention of the government.

The government has established itself as the savior of last resort to save farmers which made risky bets; mainly by providing subsides and other transferences. Government has succeed to achieve this goal but it also has succeed in create powerful farm organizations to keep alive their ricardian rents and empower their influence in political process to guarantee their survival without market rules. In the next years, as the downturn get painful, agave producers will become a powerful political organization, and maybe, if the worst happen, we will see an organization of avocado producers too. These organizations will be embraced with gusto by some political party (traditionally PRI has done) to perpetuate the old way to doing business in the Mexico countryside, and maybe, contributing to the formation of other micro bubbles. 

Filling the Gap between Economic Growth and Financial Development

The current economic crisis has erased a significant portion of global wealth. However, developing nations in its path toward development and the revaluation of financial assets will cause a renewed offer of financial resources in search of investment alternatives in coming decades. This fact, called by Bernanke as "Global Saving Glut", will continue affecting financial flows and the economic global performance, and mainly, may damage the economic conditions again through creation of bubbles and promoting imbalances on external accounts as is happening with USA and some Asian countries. That is the reason why is important to take appropriate decisions with the goal to improve the world financial architecture.

The root of the current U.S. mortgage crisis was the high supply of mortgages with low interest rates and poor risk assessment policies. This was possible from a set of economic developments, of which four I think deserve special attention:

First, the technology shock by the introduction of technologies based on silicon increased significantly the levels of productivity in the economy. Among its implications, one very important was that technological advance caused less funding needs to business investments  because it allowed create more value added with smaller amounts of financial resources, freeing resources for other economic sectors, particularly to funding consume and housing.

Second, the high degree of openness, depth and incentives for financial innovation in financial market of U.S., make it the most attractive place for investments in the world. The investment alternatives in the nation, besides being large in relation to other markets, have liquidity; enjoy legal protection, trust, and transparency. This availability of resources allowed to financial intermediaries raised money easily and brings it to their citizens at lower cost through consumer and housing credits.

Third, China’s imprudent exchange rate policy. Economic planners in this country guided their vast amount of labor resources toward industrialization for exportation; where the cornerstone was keep an exchange rate as undervalued as possible. This situation reduced the external demand, mainly consumer goods; international reserves rose to extraordinary levels; and that situation was deepened by the high savings rates of their households, not only for saving for precautionary purposes, risk of be fired (after all, the economy was strong), demographic profile or consumer habits, but it was important too, the absence of lending instruments for financing the purchase of housing and durable consumer goods. This caused an enormous amount of dollars which could only have a single market destination, a market of large sovereign debt (giving the recommendations on risk management of international reserves by a central bank); and it was only available the U.S. governmental market that met this requirement, causing a huge debt market, with its seemingly benign implications for monetary policy and fiscal United States (sustainability of the twin deficits) and their impact on the availability of credit and disposable income of consumers in United States.

 

Fourth, low development in financial systems of developing economies. Under free market conditions, it is expected that economic growth of a nation is reflected in a development more or less similar in its financial system. However, it has not happened in many nations. For example, Venezuela was unable to channel more efficiently excess oil revenues because its expansionary fiscal policy, poor property rights, lax laws regarding the recovery of delinquent collateral clients, government intervention in banking, and high inflation by inappropriate monetary policies; these factors prevented the proper functioning of financial intermediaries to allocate better the high surplus of revenues. The same happens in other nations at different intensities and with negative results. Affecting not only the loss of funding opportunities of important sectors such as education, housing, business, technological innovation and improvement of public finances, but also by limiting the investment international opportunities to  few financial markets as Unites States, causing the glut in financial resources in a few development financial spots and low interest rates in some markets. Sadly, these countries didn't create the financial frame to promote their development.

Asymmetrical development of the financial system in developing nations has not been given enough attention as a cause and solution of this financial crisis. The current situation a decision needed and automatic will be downsize the nation's financial sector in economies typically "obsessive" of global savings (USA, Spain, Ireland, Iceland, etc.), But the huge supply of resources will continue there, and will require more and better balanced financial systems in countries with high development potential (China, India, Argentina, Mexico, etc.).. The incentives are clear, through a harmonious development between the real economy and financial system, economic growth is sustainable, durable and beneficial to the welfare of their societies.

Obviously, this won’t happen overnight. It must address carefully and the form of system evolve in each country will determine the financial success of their results. In this regard, the International Monetary Fund and other global financial authorities will be responsible for providing guidelines on how each country to develop its financial infrastructure. However, the general principles should aim to: encourage competition in financial services, improve the legal framework for recovering the collateral upon default, encourage the use of the stock market by the companies as a channel of funding, encourage the use of funds from the retirement savings for private investment in other financial instruments, promote the creation of an information market to value financial instruments, balancing public finances, keep the good monetary policies, promote financial literacy among the population, improve the arrangements bankruptcy, and others concerning regulation matters.

In countries which had problems recently in their financial system, the adjustments are clear: more regulation, more transparency, less non-bank intermediaries unregulated, the change in incentives to avoid recurrence of the "moral hazard" created by the background in this recession, and so on. But in those countries that remained immune, they need to play a more active role in reducing systemic risks, balance the global imbalances, and doing so, encourage the economic growth endogenously.

Filling the Gap between Economic Growth and Financial Development

(Spanish; English version soon).

La presente crisis económica ha borrado una importante porción de la riqueza mundial. Sin embargo, las naciones en desarrollo en su ruta a la convergencia económica, y la revaluación de los activos financieros, causará un renovada oferta de recursos financieros en búsqueda buenas alternativas de inversión en los próximos decenios. Dicho fenómeno, denominado por Bernanke como “Global Saving Glut”, continuará afectando los flujos financieros, y de bienes y servicios, pudiendo afectar la salud económica de nuevo, a través de creación de burbujas y desajustes en la balanza de pagos en varios países, en el caso de que no se tomen las decisiones adecuadas al respecto.

La raíz de la crisis hipotecaria de Estados Unidos fue la elevada oferta de créditos hipotecarios, con bajos intereses y con pobres políticas de evaluación del riesgo de impago a los usuarios de los créditos. Lo anterior fue posible a partir de un conjunto de fenómenos económicos, de los cuáles cuatro me parece merecen especial atención:

1. El shock tecnológico positivo de las tecnologías basadas en el silicio, incrementó significativamente los niveles de productividad en la economía. Entre sus implicaciones, una muy importante, es que causó que las necesidades de financiamiento de inversión de negocios bajaran al poder crearse más valor agregado con cantidades menores de recursos financieros, liberando recursos para financiar otros sectores económicos, en particular a los hogares de Estados Unidos.

2. El alto grado de apertura, profundidad e incentivos a las innovaciones financieras, hizo del mercado financiero norteamericano el lugar más atractivo para los inversionistas en el mundo. Las alternativas de inversión en esa nación, además de ser amplias, en relación a otros mercados, son líquidas, gozan de protección legal, confianza y transparencia. Por lo que se afianzó como un destino importante de recursos a nivel mundial. Dicha disponibilidad de recursos, benefició a los intermediarios financieros de ese país para recaudar dinero con facilidad y llevarlos a sus ciudadanos a bajo precio, a través de créditos al consumo y a la vivienda.

3. Una política cambiaria errónea de China. Los planeadores económicos de ese país le apostaron a dirigir la enorme cantidad de recursos laborales que se estaban desprendiendo hacia la industrialización para la exportación, donde su piedra angular fue mantener un tipo de cambio devaluado. Lo anterior suprimió la demanda externa, elevó las reservas internacionales a niveles extraordinarios, y se agudizó por las elevadas tasas de ahorro de sus ciudadanos, no sólo por ahorro para fines precautorios por una eventual pérdida del empleo (al fin y al cabo la economía estaba creciendo de manera robusta), perfil demográfico y hábitos de consumo, sino por la ausencia de instrumentos crediticios para financiar la compra de vivienda y de bienes de consumo duradero. Lo anterior causó una enorme cantidad de dólares cuyo único destino podría ser un mercado de deuda soberana (por las recomendaciones en administración de riesgo de reservas para un banco central) lo suficientemente grande. Sólo el mercado de Estados Unidos cumplía dichas características, causando un mercado de deuda muy grande, con sus implicaciones aparentemente benignas en materia de política monetaria y fiscal de Estados Unidos (sustentabilidad de los déficits gemelos); y sus efectos en la oferta de crédito e ingreso disponible del consumidor estadounidense.

4. Pobre desarrollo del sistema financiero. En condiciones de libre mercado, se espera que el crecimiento económico en una nación se vea reflejado en un crecimiento más o menos similar al de su sistema financiero. Sin embargo, no ha sucedido en muchas naciones. Por ejemplo, Venezuela no pudo canalizar de una manera más eficiente sus excedentes de petróleo por su política fiscal expansiva, pobres derechos de propiedad, una legislación laxa en materia de recuperación de colateral en clientes morosos, intervención gubernamental en la banca y elevados niveles de inflación por políticas monetarias inadecuadas; impidiendo una adecuado funcionamiento de sus intermediaros financieros. Lo mismo sucede en otras naciones en diferentes intensidades y con resultados negativos. Afectando no sólo la pérdida de oportunidad para financiar sectores importantes para el bienestar de sus poblaciones como educación, vivienda, negocios, innovaciones tecnológicas, y mejoramiento de las finanzas públicas; sino que, además, limitando las oportunidades de inversión de los agentes económicos con excedentes de recursos financieros, causando mayor sobre carga en sólo unos cuantos sistemas financieros, particularmente en Estados Unidos y de otras naciones desarrolladas.

Al desarrollo asimétrico del sistema financiero en naciones en desarrollo no se la ha prestado atención como causa y solución de la presente crisis financiera. Frente al actual panorama una decisión necesaria y que será automática es la reducción del tamaño del sistema financiero de naciones habitualmente “tragonas” de los ahorros mundiales (Estados unidos, España, Irlanda, Islandia, etc.); sin embargo, la enorme oferta de recursos continuarán ahí, por lo que será necesario mejorar y aumentar armónicamente los sistemas financieros en naciones con elevado potencial de desarrollo (China, India, Argentina, México, etc.). Los incentivos son claros, a través de un desarrollo armónico entre la economía real y el sistema financiero, el crecimiento económico es sostenible, duradero y beneficia el bienestar de sus sociedades .

La forma que tome en cada uno de los países los sistemas financieros determinará el éxito de sus resultados. En éste aspecto el Fondo Monetario Internacional y otras autoridades financieras globales, deberá encargarse de dar las pautas de cómo podría desarrollar cada país su sistema. Sin embargo, los principios generales deben estar encaminadas a : Incentivar la competencia en los servicios financieros, mejorar el marco legal para recuperar el colateral en caso de incumplimiento, incentivar el uso del mercado accionario por la iniciativa privada como canal de financiamiento, alentar el uso de los fondos del ahorro para el retiro privado para la inversión en otros instrumentos financieros, fomentar la creación de un mercado de información para valorar los instrumentos financieros, balancear las finanzas públicas, fomentar una cultura financiera en la población y mejorar la estructura de arreglos de banca rota.

En los países que tuvieron problemas en su sistema financiero las medidas están claras; más regulación, más transparencia, menos intermediaros financieros no bancarias, cambio en los incentivos para evitar la recurrencia del “riesgo moral” por los antecedentes creados en ésta recesión, entre otros. Pero aquellos países que se mantuvieron inmunes, es necesario que jueguen un rol más activo en reducir los riesgos sistemáticos, balancear los desequilibrios globales, y haciéndolo de ésta manera, fomentar el crecimiento endógeno.

The Agricultural Puzzle in México

The extreme poverty in Mexico is increasingly concentrating in rural regions. According to CONAPO, “[w]hile in 1992 the percentage of rural poor […] was about 2.7 times that seen in urban areas, [..]in 2000, the ratio increased to 3.4 times”. This unfortunate outcome is partially linked to the poor performance of agricultural activity, the main economic activity in rural regions. During 1993-2006, the sector grew 1.9%  annually while rest of the economy did it by 3.7 percent. And most important, those states where the rural poverty is concentrated, as Chiapas, Oaxaca and Guerrero, this sector grew modestly, 1.7 percent annually (in per capita terms the growth was negative given that these estate have high rates of natural population growth).

 

This fact supports agriculture policies as tool to reduce poverty. For example, a crucial thesis that shares any agriculture policy is, to reduce poverty in rural regions is condition improve technological capabilities of farms. That will elevate agricultural yields, and it will cause a major agriculture surplus. The agriculture surplus, as Adam Smith wrote centuries ago, allows support other economic sectors, given the gains from agricultural activity that leave resources to be employed in other economic activities. That fact justify why the Mexican government support directly purchase of tractors by farmers (Acquisition of Productive Assets).  

 

The objective to improve the technological endowment of farm in Mexico has been partially achieved. According to agricultural census of 2007 and 2001; the quantity of tractors has raised very importantly in the period. The importation of fertilizer, in real terms, grew outstandingly. And other agricultural inputs grew heavily too. But its consequences, the desired growth in productivity and agricultural income, has not been achieved.  The corn yield in Mexico has grown steadily, 44 percent throughout the period 1992-2007 (without Chiapas, Oaxaca and Guerrero). However, corn yields in Chiapas, Oaxaca and Guerrero, where poverty principally is and main agriculture product is corn , has not shown any secular increase in their yields, the yield increased only 10 percent in the same period.

 

But it is not only the hypothesis of technological support to boost farm productivity that has not worked; there are more. There are many assumptions behind the underdevelopment in agricultural sector has been broken that has not worked yet. Principally those reforms started during the modernization of our economy, early 1990 decade. For example:

 

·        The constitutional reform related to the article 27, didn’t result in how it was predicted. Land tenure, despite being private (after a long period being a semi-estate ownership tenure), is still highly dispersed, causing that scale economies required to produce competitively corn, for example, has not been reached.

 

·        Minimizing price volatility through price coverage to reduce income uncertainty, has not allowed increase investments to produce more efficiently. Further, the scheme  has create incentives to produce those products that enjoy this support, limiting the diversification induce “naturally” by market --according to prices movements and other economic and natural advantages.

 

·        Hydraulic infrastructure. One of the main hydraulic project, supported during the tenure of Carlos Salinas de Gortari, the Aguamilpa Damn, was built not only to hydroelectrically energy purpose but to improve agriculture activity. Its results are very limited, in Nayarit, where the dam was built, irrigable area in the state dropped from 61,790 hectares in 1992 to 56,411 hectares in 2007, given lack of market opportunities to demand for water to irrigation, lack of complementary irrigation infrastructure, and geographic limitations.

 

Thus, the fight against rural poverty shows a very uncomfortable outcome. Given the relation between rural poverty and agriculture economy activity, is important make a deep revision of agricultural policy in Mexico and its assumptions. Maybe the incentives created to keep some prices artificially high --namely, corn and sugar cane, have limited the productive diversification. Maybe it requires more market rules. Perhaps, as government implicitly thinks, we need time to see results, the learning curve is very long and for better results we must waiting for and expect the culmination of the natural urbanization process in Mexico to see better figures in poverty fight. Or maybe we must evaluate the return of those old programs as technical assistance, subsidies to inputs, and remake our agriculture development banks with enough fund to finance intensively this activity, or create regional policies according to every region problematic, to solve this problem.

 

It is not enough offer the classical receipts to have quick results. As every current economic puzzle, from current financial crisis to the classical equity premium puzzle, solve low levels in agricultural yields demand extraordinary discussions, proposals, a serious commitment, and policy actions by government and private involved, because that is crucial to solve the poverty.