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Women Empowerment and Microfinance in Pakistan

Micro Finance Institutions are gateways that provide the poor and vulnerable people access to such credit. Lack of education and financial knowledge, poor socioeconomic conditions, family restrictions for females are some reasons why MFI fails to meet its goals. For such growth and development to take place, the role of females and particularly the involvement of females in the economic activity are very important. Access to money and women empowerment is important factors that contribute to the development of a country. In Pakistan the concept of borrowing from proper financial institutions is very low and in most cases restricted to large corporations. The usage of micro credit by the majority, particularly people living in rural areas is very low as still majority tends to save or borrow from their friends and family members. According to World Bank statistics around 14% of the people are taking use of services from a formal financial institution and when informal sector is taken into account 50.5% have access to finance. Of them nearly 50% don´t engage in any kind of formal or informal financial system and around “19 percent have voluntarily excluded themselves through lack of understanding, awareness, or need, due to poverty, or for religious reasons. This research paper will discuss how microfinance has aided women empowerment in Pakistan and the factors that contributed to the success of MFIs.The paper will also focus on the drawbacks of MFIs and the hindrance caused by some of their policies for women willing to raise capital for their future ventures.
Literature Review
Niethammer,Tania Saeed,Shaheen Sidi Mohamed,and Yasser Charafi (2007) states in the article that women’s lack of access to finance is one of the key constraints for economic growth and that economic development and women empowerment are interrelated.the authors then answer the question of why is important and it is important because of the following reasons
Poverty alleviation and improved social wellbeing
55.8% of women as compared to 41% of men are living below poverty line.Programs give access to savings and helps in smoothing the incomes of the poor and ensures predictable revenue streams.Majority of the women view the increase in their income as a vehicle for improving their status within the household.The women aimed to improve their status through having their own income(85%),freedom of mobility(70%), and equal decision making power with men (92%).
Female employment generation
Female labor force participation rate is the lowest at 15.9%.Women entrepreneurs in the SME sector provide greater employment to women.
The economic justification for providing women access to finance
Women entrepreneurship is on the rise.Women are a minority f the borrowers of the Ngo credit-the Pakistan’s microfinance sector has not been able to scale up as successfully as other countries.Increase in economic activity of women in Pakistan can represent a potentially profitable market niche for the financial sector.
Obstacles to women’s access to finance-demand side issues
There is lack of access to FI to fund their startups and business expansions.Women don’t know how to access formal finance and hence remain undercapitalized as they often do not meet minimum borrowing requirement.Women faced difficulties in mobilizing start-up capital, credit guarantees, investment capital, and experienced discrimination from bankers.
Obstacles to women’s access to finance-supply side issues
Rural financial market study shows that men have over three and a half times greater access to finance as compared to women in rural areas.Men borrowed 91% of large loans.Sme do not have products and services that meet the need of women-small service sector business hence higher risk.Biasness caused by social and cultural prejudices-ignore economic participation
The author offers a few Recommendations to improve the situation and these include:develop financial products that cater to women entrepreneurs; help women become more bankable clients through nonfinancial services;promote financial sector outreach to women;promote women’s access to microfinance;and implement sound policies.
Sylvain Dessy and Jacques Ewoudou(2006) in their study focuses on how loans and training through MFI create female entrepreneurs particularly in the developing countries and terms it as an “opportunity to earn independent income”. They conduct a “game theoretical model of activity” under which they conclude that giving loans to women would not be enough in order to make them successful entrepreneurs, “condition for MFIs to succeed in nurturing female empowerment is that access to women’s credit be conditioned to their adoption of high-productive informal activates”.The game-theoretic model highlights coordination failure that hinder the emergence of networks of female entrepreneurs necessary to overcome patriarchal business practices that limit female entrepreneurs’ access to high-productivity informal activities.Two pure-strategy Nash-equilibria: a high-income equilibrium where all of them operate high-productivity informal activities and a low-income equilibrium where they all remain confined into low-productivity ones, despite access to credit. Therefore, when the low-income Nash-equilibrium obtains despite women’s improved access to credit, it must be that microfinance assistance to female entrepreneurship has failed to act as a coordination mechanism for the emergence of large enough networks of female entrepreneurs operating high-productivity activities. wherever microfinance has failed to empower women-in the sense of enhancing their involvement in high-productivity activities-, we concluded that it may be because of coordination failure that prevent women from creating business networks large enough to mitigate patriarchal forms of business regulations that put them at a comparative disadvantage, relative to men, at managing high-productivity business ventures.We found that a sufficient condition for MFIs to succeed in nurturing female empowerment is that women’s access to credit be conditioned to their adoption of high-productivity informal activities. Such conditionality will act as a coordination mechanism, allowing female entrepreneurs to organize in large enough networks that raise women’s gains from operating high-productivity activities in the informal economy.
Cheston Susy and Kuhn Lisa(2001) placed emphasis on various channels through which Microfinance works. They include MFIs, banks, NGOs and other non banking financial institutions. Most of these financial institutions target women as they are the most vulnerable and “poorest of the poor” part of the society and without empowering them, development couldn’t be achieved.
Mohammad D. Sulaiman defines microfinance in his article as ” a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers” according to the oxford dictionary. Microfinance helps in pulling people out of the vicious circle of poverty by providing access to finance at their doorsteps at very easy terms and conditions. Microfinance has the following key function according to Wikipedia:
1. Deprived segment of the society need a diversity of financial services, not only loans
2. It is powerful instrument to fight against the poverty
3. It is a source to build financial systems may be useful to serve poor.
4. It must pay for itself to accomplish large numbers of poor people.
5. It is about building perpetual domestic financial institutions.
6. Micro credit is not the suitable instrument for everyone or in every situation.
7. Mark up ceilings making it difficult for poor people to get credit.
8. the task of government is to enable financial services, not to provide them.
9. The funds of the donor should be supported to private capital not to compete with private Capital.
10.shortage of organized institutions and managers are the main obstacles are Microfinance.
Also there is a difference between charity and microfinance, charity is given to fulfill needs whereas microfinance is given to poor people to start their own business and find a way to earn livelihood.The ratio of women making use of microfinance loans is high compared to previous years but very low when compared to that of the neighboring countries. It needs to be increased if women empowerment is to be pursued as an objective of microfinance. How ever the recovery rate of the loans is higher amongst women and they’re the preferred consumer of these loans.
Herani, Gobind M(2010) says that microcredit has been initiated with an initiative with an objective of providing credit to poor people without collateral. The criteria of providing credit, discipline and harmony of group members, collection of repayments, supervision of borrower’s activities in micro credit system has played a major role in replacing the collateral. This has encouraged women to take up more loans as they can go in groups to get finance for their projects and then pay off the loan collectiviely.microfinance gives women a chance t diversify their portfolio of assets-social, human,financial,natural and physical capital. The success of microfinance schemes rely on the following questions: whether all the donated/allocated funds are properly utilized? Whether these allocated funds are distributed among the rightful hands? Whether these transactions of funds are observable by donor? Whether deposits can be got from targeted population.
Swain Bali Ranjula and Wallentin Yang Fan (2007) in their article state that women empowerment depends on the norms and culture of the society they live in. Microfinance helps in empowering those women who are amongst the poorest and the most vulnerable. It also presents an increase in women’s resources which helps them achieve improve earnings and well being. It also discusses the women’s traditional role in society and how they promote gender equality.
Jamal Haroon(2008) evaluates the impact of microfinance programs on income, expenditure, child education and women empowerment. According to the author, The beginnings of the Microfinance sector in Pakistan has its roots in the rural development projects that were funded by donors like The Aga Khan Rural Support Programs. The GOP and various rural support programs feel that microfinance can be used as an important tool for women empowerment. He has done sample study based on various range of sizes, ownership patterns, sources of funding, lending methodology, program area, organizational structure, borrowers and communities . The variables used in the study were Income and Expenditure (Household Expenditure (Per Capita), Household Income (Per Capita), Respondent Income, Household Asset Score, Household Expenditure on Education, Household Expenditure on Health) Child Education (Percentage of School Going Children (6-15 Years), Percentage of School Going Girls (6-15 Years) and Women Empowerment (Economic Aspects, Income and Expenditure, Asset Transactions, Education and Health. He reached the conclusion that microfinance helps in smoothing consumptions and generating incomes. However the econometrical results regarding women empowerment are mixed, contradictory and in many cases, unexpected. Therefore the microfinance interventions do not seem to have a significant positive impact on the different aspects of women empowerment.
Linda Mayoux(2006) defines women empowerment as the participatory process through which women, who are currently most discriminated against, achieve gender equality and equity. Where the extent of women’s disadvantage means that they are unable to fully promote their own interests, this will require support by development agencies at household, community and macro levels. This will include support for men to change those aspects of their behavior, roles and privileges which currently discriminate against women.An essential element for women empowerment is the change in men’s attitude towards women. If men don’t have a liberal approach towards it than microfinance cant help women in anyway as in our society the men are most dominant.An urban poverty Alleviation project (UPAP) imitated by the national rural support programme (NRSP) shares this drawback. In order to receive a loan from this project women have to be accompanied by any one male of the family. If such restrictions are played on women than they can’t be independent. Also usually the loans taken up by women are used by the male heads of the family and they leave the women after they receive the finance to repay the loan. It should be made compulsory for women o use the loan themselves and put their skills to use. Also they should take training of skills that can help them in setting up their own business rather than relying on the males of the family.
She also talks about the paradigms’ on micro-finance and gender which are Financial self-sustainability paradigm ,Poverty alleviation paradigm and the feiminst empowerment paradigm.The Financial Self-sustainability paradigm is currently dominant within most donor agencies and in the models of micro-finance promoted in publications by USAID, World Bank, UNDP, CGAP and the Micro-credit Summit Campaign. Here the main consideration in programme design is provision of financially self-sustainable micro-finance services to large numbers of poor people, particularly micro- and small entrepreneurs. In this paradigm, it is assumed that increasing women’s access to micro-finance services will in itself lead to individual economic empowerment, well-being and social and political empowerment.The Poverty alleviation paradigm underlies poverty-targeted programmes. Here the main considerations are poverty reduction among the poorest, increased well-being and community development. The focus is on small savings and loan provision for consumption and production, group formation, etc. Gender lobbies in this context have argued for targeting women, because of higher levels of female poverty and because of women’s responsibility for household well-being. Poverty alleviation and women’s empowerment are seen as two sides of the same coin. The feminist empowerment paradigm underlies the gender policies of many NGOs and the perspectives of some of the consultants and researchers looking at gender impact of microfinance programmes (eg Johnson, 1997). Micro-finance is promoted as an entry point in the context of a wider strategy for women’s economic and socio-political empowerment.The focus here is on gender awareness and feminist organization. Some programmes have developed very effective means for integrating gender awareness into programmes and for organizing women and men to challenge and change gender discrimination. Some also have legal rights support for women and engage in gender advocacy.The paper concludes that women’s empowerment needs to be an integral part of policies. Empowerment cannot be assumed to be an automatic outcome of micro-finance programmes,whether designed for financial sustainability or poverty targeting. More research and innovation on conditions of micro-finance delivery is needed. The paper finds that cost-effective ways of integrating micro-finance with other empowerment interventions, including group development and complementary services are still lacking. Unless empowerment is an integral part of the planning process, the rapid expansion of micro-finance is unlikely to make more than a limited contribution to empowerment.
Mumtaz Soofia(2000) in this paper examines the gender component of the Urban Poverty Alleviation Project (UPAP) initiated by the National Rural Support Programme(NRSP) in Rawalpindi and Islamabad.UPAP gives loans to self-constituted groups of women who would be considered uncreditworthy by normal banking standards. Micro finance schemes target women as clients because they constitute the poorer half of the most disadvantaged section of the population. Concentrating on women is expected to move the household out of poverty, because women contribute their incomes to household welfare. The status of the borrower receives a boost because the value of women within the home is known to increase with the generation and management of monetary income. Efforts at mainstreaming women thus seek to increase their independence within and outside the home. Empowering women, and enabling them to use the loan themselves, will ‘boost’ the household economy. Expecting the borrower to contribute all her income to the household, without empowering her, is tantamount to exploiting her disadvantaged position, and perpetuating her subordination.
Economic Development
Government development projects
Role of MFI’s

Economic And Policy Implications Economics Essay

Chapter 5 The principal feature of the Immiserizing Growth theory is the phenomenon of positive economic growth and subsequently an inferior outcome, the theory indicates the existence of sufficiently large distortions -exogenous and by imposed policy- that outweigh the gains from growth. This dissertation has been totally devoted to investigate the empirical reality of immiserizing growth in a consistent theoretical framework. Although immiserizing growth theory has been regarded as a theoretical issue rather than a real-world matter, our analysis identified the existence of episodes of immiserizing growth in the post-war South American economy. Our results confirm that these set of countries had serious distortions on economic activities and affirm that immiserizing growth is a real-economy issue under certain circumstances of high distortions, resulting in a significant loss of welfare and economic growth. However, we believe it deserves further empirical studies, especially careful country-specific case studies such as Kaplinsky, Morris and Readman (2002).
We carried out a systematic analysis of this theory and argued that the results are derived from the South America’s experience over the last fifty years of its economic history, between the golden-age of the import substitution strategy (ISI), increasing deficit budgets, high external debt and inflation problems -debt crisis-, related to the region’s macroeconomic distortions.
On the other hand, the importance of examining the determinants of long-term economic growth are essential for the development on Latin American economies, and to understand better the roots of its economic performance, as well as the interaction with other fundamental variables on growth. Finally we present conclusions, and at the same time suggestions for economic policy and the avenue for further research on the subject.
As part of our expectations on the results are, if we find that institutions variables are insignificant, while macroeconomic policies are important on growth, the most accurate interpretation, it shows a large ‘causal’ effect, which institutions have an effect on volatility and viceversa, where specific macroeconomic policies [1] are the main mediating channel for this effect. Since macroeconomic policies are the key primary channel, the results suggest that getting macroeconomic policies right is likely to have policy priority and solid institutions.
Finally, if we find that institutions are significant and macroeconomic policies are not, the most correct interpretation is that the causal effect of institutions on volatility is not mediated mainly through macroeconomic policies, but through a range of other, probably microeconomic channels. In this case, macroeconomic policies might still have an effect in individual cases; but they are not the principal channel. Therefore, these results favor an interpretation in which standard macroeconomic variables have a secondary role creating economic instability; however, the volatility of the exchange rate appears one of the channels linking weak institutions and greater instability, even if it is not the primary channel.
Reflections from the empirical findings Openness and Institutions
From our empirical results in both papers, we want to disentangle two results, which are of relative importance to both the theory and empirical evidence, the first is related to openness, and the latter the key role of institutions. At first sight the openness indicator used appears to be a not appropriate measure for openness. A number of researchers have followed this line, attempting to remedy the faults that we had found [2] , however, there is not a clear association between trade policy indicators and growth, and it seems that more open economies did not fare better than less open economies. According to other measures of openness, tariff restrictions are actually better instruments and have negative association with growth.
Our results show trade ratios maintain a strongly significant coefficient in these regressions but with a negative direct effect on growth. Since we used institutions as instrumental variables, the results confirm the relevance of institutions on growth. Quoting two recent studies on these issues, Rodrik, Subramanian and Trebbi (2002) and Rigobon and Rodrik (2004) using cross-section evidence and geographical variables show that institution variables consistently comes out with a significant coefficient in these regressions, whereas geography displays an insignificantly positive coefficient and the coefficient on the trade/GDP ratio actually turns negative and significant. Considering these evidence as support, we may conclude that the direct linkage between openness and growth is not clear at all, and must be necessary the use of other trade instruments as well as methods.
In contrast, if well openness is estimated to negatively affect income levels, it reinforces investment, since it is significance and positive on investment, it works through a more open economy which attracts inflow capitals, international transmission of technology (Diamond, 1997) and patterns of specialization (Engerman and Sokoloff, 2002).
On the second hand, we are not fully agree that tariffs as an openness instrument, our data shows that it is not hard to find country-specific cases where measures such as average tariffs are a very poor indicator of trade policy. For example, in Chile and Colombia one can point to specific administrative changes that significantly liberalized trade. The growth of Chile’s international trade has been spectacular in the 1990s, which is clearly related to the reduction in a wide range of administrative barriers to trade as part of free-trade agreements with U.S and Europe.
Institutions, volatility and economic performance
After applied a new methodology to measure terms of trade volatility, we got definite conclusions respect to terms of trade volatility and macroeconomic distortions, from the panel model the presence of macroeconomic volatility is robust in all equations and have negative effects on investment and further growth. The statistical interaction with other variables is higher when we consider natural resources abundance -oil production-, which reinforces the negative impact on growth. The findings that oil wealth with not solid institutions are probably ingredients for social unrest and political instability is elusive.
Overall, the results presented in this subsection suggest that the component of institutions has a direct effect on the growth equation, and the production of oil seem to be an important negative channel on growth, regarding the investment equation, macroeconomic volatility is typically negative correlated with investment, also the U.S. interest rate is negative. Our interpretation of these results is that the impact of volatility varies through institutional frameworks across countries; these differences create economic instability through a variety of microeconomic channels as well as the habitual macroeconomic channels. These results confirm the conclusion of the previous section that there appears to be a close a link between institutions and economic instability, however, the presence of natural resources is highly significant and has a negative effect on growth and investments.
This suggests and confirms that natural resources abundance has an effect on growth and, that institutionally weak societies may slow down more than others. Commodity prices translate into greater volatility for these economies during periods of world economic slowdown; and it is likely that the inability of the political institutions to deal with their own idiosyncratic problems underlies their economic instability. The effects of different institutions on volatility do not appear to be primarily mediated by any of the standard macroeconomic variables. Instead, it appears that weak institutions cause volatility through a number of microeconomic, as well as macroeconomic, channels.
The economic impact of macroeconomic volatility in terms of economic growth is high, we found that institutional ‘shock absorbers’ are critically important determinants of macroeconomic volatility; in particular, our evidence points toward the importance of the exchange-rate regime and external exposure from terms of trade volatility. At the end, it came to realize that macroeconomic volatility is part of bad economic performance and lower growth rates.
Regarding the globalization dilemma, we found a negative sign of openness over economic growth, but in the other hand, it is highly significant and favorable through the investment channel, in this view, openness plays an important role increasing productivity trough investment; in this way, we suggest the benefits of trade are more visible from the 1990s during the broad macroeconomic reforms and through new technologies in local production.
Why have South America suffered very high volatility and severe crises over the postwar period? The standard answer is that they have followed unsustainable and distortionary macroeconomic policies until the debt crisis. In this document, we developed the argument that the principal cause of instability was due to incorrect macroeconomic policies and weak institutions. Considering the results of the panel, the only “macro” variable which appears to play an important mediating role is the real exchange rate volatility, which is consistent with the discussion on weak institutional cases, where real overvaluation was used as a method of expropriation or redistribution.
This is consistent with the view that there is a causal relationship between improvements in economic freedom and faster rates of long-term growth. In another way, the evidence indicates that improvements in institutions enhance growth, but there is no evidence that stronger growth enhances institutional quality. Second, it indicates that poor economic performance often creates a fruitful environment for constructive institutional change. A crisis situation is more likely to result in institutional improvements; this view is consistent with Pitlik and Wirth (2003).
Distortions and macroeconomic policies
During the early years of ISI, there were introduced a set of anti-market policies that altered dramatically economic growth. These new measures resulted in high inflation rates, the development of ‘black’ markets, and a contraction in international trade and overvaluated exchange rates. The market critics of import substitution strategy have long pointed to the accumulated distortions and inefficiencies resulting from high protection that prevailed in most of the countries. Consequently, interventionist state policies, in particular, high trade protection, led to massive alterations that caused widespread economic inefficiency and a lack of technical progress.
The effect of policy distortions on the long-run growth rates have been traced through the elaboration of the macroeconomic disturbances indexes (IMD); here we have contributed to the development of the topic with several practical innovations using the Pena Distance methodology. Although is difficult to measure a policy negative effect, we have considered objective macroeconomic variables: inflation, interest rates, exchange rate depreciation, the black market premium rate, tariffs and the price of capital. Where, only the price of capital and the exchange rate depreciation appear to have a long-run effect on fundamental variables.
Several broad lessons could be derived from this historical investigation. First, we have shown the advantages of case studies and the usefulness of the index of macroeconomic distortions assessing the impact of economic policies on output performance. Second, as a consequence of the persistence of autarkic policies in the 1990s, combined with an institutional environment inimical to foreign investment, South America’s growth rates have been low compared to other regions, also it is evident that the region was prompt and weak to foreign volatility. And, the findings stress the importance for macroeconomic stabilization in developing countries as first step to posterior growth and stability against external shocks. Thus, it seems the case that the policies of the ‘Washington consensus’ were in part right to establish stabilization.
The general result from the econometric model is that economic growth is positively correlated with capital accumulation and investment, while the latter variables are negatively correlated with policy distortions and positively correlated with openness. This perspective does suggest that macroeconomic policies do matter for developing economies. However, we want to emphasize is that there are deeper institutional causes leading to economic instability, and these institutional causes lead to bad macroeconomic outcomes via a variety of mediating channels.
Another explanation could be that bad policies are a result of poor institutions, the policy implication of this explanation is that bad policies are only symptoms of longer-run institutional factors, and correcting the policies without correcting the institutions will bring little long-run benefit and growth stagnation.
We can therefore conclude that some societies pursue distortionary macroeconomic policies, in the form of high inflation, large government sectors, overvalued exchange rates and other distortionary macroeconomic prices because they have (or have had) weak institutions. This raises the question of whether the correlation between the distortionary policies and macroeconomic volatility reflects macroeconomic policies, or the direct effect of institutional problems working through other potentially non-macroeconomic channels.
Further comments
In particular, the findings for developing countries have to be interpreted with caution, mainly because of data limitations, short observed time period, as well as intrinsic problems of measuring and explaining growth in countries that went through such a major structural breaks.
Growth is positively correlated with fundamental variables with theoretical link to investment, in that way income levels and growth rates are not significant with trade shares, it may be as a result that our measure is an imperfect and endogenous measure of trade policy. Armed with this evidence, the effect of openness on growth is still elusive. We continue believing in the importance and the gains from the data panel, but in the cross-section of countries, the empirical evidence found that trade and institutions are strongly linked to common historical and geographical determinants in the long-run.
Regarding the institutional measure, there are number of obvious problems with the regression, specially finding instruments for long-run data. The first is the endogeneity of the quality of institutions: subjective measures of institutional quality may be subject to “halo effects”: countries are perceived to have good institutions because they are rich already. Second, probably there are omitted variables correlated with both per capita incomes and institutional quality in an econometric model such as this one. Considering the results from -Contract-intensive Money and Financial Deepening- are negatively related with growth, this may as a result that of weak financial intermediation, the financial openness is low compared to other industrialized regions and behind the low development of private institutions.
Economic and policy implications No simple analogy can be easily drawn, among South America’s historical experience and the expected outcomes of similar policies in today’s world economy. Perhaps, the main lesson is that economic results of any growth strategy depend, to a large extent, on its ancient context and institutional framework inherited, in some way relied on crucial human capital base, which is currently lacking in many developing countries. Other several particular circumstances made difficult the co-existence of an industrialization strategy with macroeconomic and financial difficulties, low capital formation, a set of external and domestic pressures on fiscal balances, the persistent dependence on high terms of trade, and a state intervention that produced restrictions on foreign investment, government allocation of credit, and so on.
The region’s reliance upon natural resource exports leaves it highly vulnerable to terms of trade shocks, a vulnerability that is apparent now, as the region’s economies are being benefit by the increments of commodity-prices. This vulnerability demands a policy response, to reduce the impact of shocks on the domestic economy and population welfare. An extended discussion of these issues would take us too far, but here we merely note some important revisions for the fiscal policy, the public debt management, and in the regulation and supervision of the domestic financial system.
A seasonal oversight
In one of the latest World Economic Outlook [3] , the IMF points out that solid growth in Latin America are driven by domestic and external demand. According to the IMF figures, the current account deficit remains on a deteriorating path but strong capital inflows, both FDI and portfolio, are keeping the balance of payments in positive territory.
In the other hand, in most countries, high food prices, as a result of adverse weather conditions, have continued to deteriorate inflation dynamics, while demand-pull inflation pressures have stayed relatively calm. Moreover, international reserves are not likely growing since there are expectations to appreciate the currencies.
The U.S. real interest rate is unusually low, and is likely to stay on the low side for some time, given the weak state of the U.S. economy. The data shows that domestic demand tends to be stimulated by low foreign interest rates; these effects have been much larger in Latin America especially in the 1970s. This response comes mainly from the private sector, if private spending reacts strongly to cheap foreign money; this additional spending can drive a widening current account deficit and a demand for foreign money to fund that deficit. Finally, if central banks react to capital inflows with currency intervention holding the exchange rate at a weak level, or even more putting limits to the rate of currency appreciation, it further will cause an exchange rate volatility.
Containing today’s risks
In general, South American financial system has managed correctly many of their old problems of inefficiency, which stemmed from government interventions, badly regulated and neglected oversight. Evidence of these improvements is that South American banks have come out of the world financial crisis. However, the depth of the credit systems continues to be very shallow by international standards, and in many countries, they have not regained the levels achieved in the early 1980s. In this way, scarce credit is one of the reasons why there are varied levels of productivity, especially in the small and medium-sized sectors that cannot make technological changes and investment to increase their productivity. Lack of credit has another damaging effect on the region, because it disincentives for informal firms to comply with tax and labor regulations. And finally, when credit finally disappears, firms are forced to close, in general, the smallest, which also is the sector with more employed.
To achieve a sustainable supply of credit and financial stability, is necessary correct the fiscal deficits, which threat macroeconomic stability; beef up financial supervision, and strengthen creditors’ property rights so that banks can lend with collateral to small- and medium-sized firms.
Since real interest rates are low; episodes of easy foreign money give rise to a range of risks, our analysis underscores the usefulness of allowing flexibility of the exchange rate (controlling the appreciation), maintaining fiscal discipline, and applying prudential financial policies to dampen unwanted credit booms. If this approach turns out to be insufficient, then carefully designed taxes on capital inflows might also be of help, on a temporary basis. However, nowadays elevated global risk aversion under tighter money and lower commodity prices represent risks to the regional economy, as they could potentially hurt the domestic economy and capital inflows.
Assuming that it might be a long term crisis rather than a temporary one, it would be necessary to adopt a package of adjustment policies, limiting increases in lending (avoid large scale debt), freezing wages and, devaluing the currency. The reason for reacting quickly with a package of policies is twofold; first, to spread a moderate impact on the whole economy, and to take moderate measures before the situation became too serious and requires drastic measures.
After a decade of reforms, what are missing and what failed? Policy lessons for exogenous risk and distortions
South American is growing today, under tremendously auspicious of international conditions. But nothing guarantees that the region will grow again once commodity prices fall back and interest rates recover to normal levels. If performance in the recent past (before 2003) is a good predictor of future performance, we have reasons to worry. South American growth in the 1990s was a lackluster region, in spite of pro-market reforms.
In this dissertation we provided new evidence suggesting that much of South America is suffering from a common symptom (insufficient growth) but likely several different diseases: weak institutions, macroeconomic disturbances, and high exposure to external shocks; also the physical capital and human capital accumulation, and technology are deficiently and seems to vary widely across countries in the region, and probably increasing divergence.
On the other hand, macroeconomic outcomes in the region as a whole have been less volatile during the 2000s than they were during the reform and pre-reform period. This is probably attributable in part to the somewhat more quietly international environment; in particular, the volatility of the terms of trade has been low by historical standards, though capital flows have remained volatile within countries probably attributed to political distortions. However, much of the improvement is endorsed to measures of monetary and fiscal policy, and structural reform efforts. However, the fiscal policy must be more stable: maintaining the fiscal surpluses in good times that would permit the budget to face up adverse macroeconomic shocks without falling into large deficits. In this brief section, we discuss the macroeconomic features of the major policy lessons that we can draw from our work.
Openness: A key element of the reforms has been a reduction of barriers to international trade, with the aim of improving economic efficiency allocating the resources to more competitive sectors, and exposing domestic producers to international competition. However, it might also be argued that greater involvement in the world economy exposes developing countries to shocks from abroad. This is likely to be particularly problematic if trade liberalization creates a tendency to specialize in the production of primary commodities, which prices fluctuate dramatically. On the other hand, our empirical results show that concentration in a few primary commodities is the consequence of the anti-export bias of trade policy during the ISI. In this way, the impact of trade openness on economic stability and growth is an empirical question not resolved in this document.
Managing international capital flows: Capital flows have remained volatile, but in low levels compared to the 1980s, and are likely to remain an important source of economic disturbance in the near future. The danger presented by short-term capital flows is essentially one of liquidity or flight of capital; if the financial resources are required to promote economic development, the economy is exposed to the reversion of investment.
Investment depends on local and foreign decisions, in that way, a particular constraint in South American politics is the expropriation risk, which results in high ex-post returns for those investments which are not expropriated. At the same time, failed institutions result in low marginal returns on human capital and infrastructure that are complements with capital investment and production.
If there is anything growth economists agree on, it is that without reasonable guarantees on property rights there can be no asset accumulation or investment in new technologies, and hence no growth. Weak institutions cannot guarantee property rights and may be threatened by the use of force of the state.
In some countries the situation is more subtle: the inability to deal with the allocation of new property rights as opportunities arise. For instance, Ecuador’s bureaucracy takes long-term periods to authorize the constructions of infrastructures to develop major oil findings. Bolivia has been unable to agree with foreign enterprises on a framework to exploit gas. On the other hand, Peru has been attracting massive investments in mining and gas, but not because of a different or better geology, but because it has had the capacity to put in place the needed contractual framework for those investments. By contrast, there are countries in South America where the ability to define and defend ownership has facilitated significant investments. Chile was able to authorize major road projects in downtown Santiago to foreign investors. Danielito2011-04-04T15:24:00
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Finally and still on debate, one of the prominent problems in sequencing reforms has exposed to unsettled capital flows at a time when their financial systems and institutional strength had still changed. This has raised questions as to whether international flows can benefit developing countries without complementary political reforms, enhance rule of law, increase transparency, and strengthen property rights.
Managing terms of trade risk
Our evidence suggests that terms of trade volatility indirectly reduces economic growth, and is also an important factor underlying the volatility of real GDP and fiscal policy. While there is little that can be done at the national level about volatile commodity prices, much can be done to reduce the impact of price fluctuations on the domestic macroeconomy. The initiatives that we promote to achieve this objective includes:
Diversified Economies through trade and investment: One way to reduce terms of trade volatility is to diversify exports, from our conclusions inward-oriented policies tend to discourage, rather than promote the desired diversification of exports because they create an anti-export bias. But diversification can be promoted through trade and investment regimes, which are most likely to exploit investment opportunities. Diversified economies are characterized by having large tradable sectors, where the volatility of commodity revenues has smaller effects on relative prices, since they have relatively flexible domestic markets.
In fact, South America’s diversification of exports has relied on unilateral liberalization and integration agreements among the region. However, terms of trade volatility makes it difficult to sustain open regimes, while openness promotes efficiency, it also creates risks, and protectionist trade policies are often used as a way of reducing it.
Regional economic integration: One outstanding aspect of trade is that has increased between members of regional trade blocs such as Mercosur, the Andean Pact countries, in that way, trade between members of a subregional trade agreement tends to be more diversified and concentrated in industrial and manufacture goods. While trade with the rest of the world is heavily concentrated in primary commodities.
Stabilization funds: Stabilization funds are essentially a spending and savings rule and are more suited to smoothing expenditure or consumption. However, today’s evidence shows that managing an oil exporting economy is an unresolved problem. The traditional idea of stabilization funds may be quite unworkable, for example, the government starts by fixing a baseline projection of oil income and then saves or uses the difference between that level and actual income (the Venezuelan experience). Moreover, matters get more complicated if a negative shock occurs and the government decides to finance the gap by using the resources saved; economic agents may interpret this behavior as non-adjustment to a permanent shock, and they won’t adjust to the real situation.
However, an outstanding commodity-producer example of fiscal adjustments is the Chilean case [4] . The Chilean government formalized the details of the procedure into law and gives the members of the panel legal independence from authorities. The rule aims at maintaining a cyclically-adjusted surplus of one percent of GDP in the accounts of the central government. Under the law, the government saves all copper exports revenues from the state copper company (CODELCO) above a long-term reference price for copper. Other central government revenue is smoothed over the business cycle, using an estimate of potential output. The two independent panels of experts estimate structural revenue adjusted for the long-term price and potential GDP. Recently, Ecuador has a similar rule for its oil exports revenues.
Minimize the risk of the fiscal accounts: Much of the volatility in the fiscal accounts comes through revenues which are generated by taxes applied on different sources: corporate profits, personal income, consumption, specific expenditures, wages, imports, or natural resource rents. All these sources carry some volatility, but some are more volatile than others. For example, consumption is typically the most stable of the major taxable sources. In the other hand, taxes on exports or on natural resources are particularly volatile, given the instability in the terms of trade. By the same token, taxes on imports are also unstable given that countries of the region often need to make changes in their import payments to adjust to external shocks. Income taxes are less volatile but reflect mainly corporate profits, which are cyclical too.
On the other hand, by choosing stable taxes, such as a broad based value added tax, government revenues can be made more stable and predictable, keeping taxes on exports and imports low in order not to distort international trade.
Managing the effects of macroeconomic distortions
When Latin America began its opening to the world economy in the 1980s and 1990s, most observers probably thought of the region as a capital scarce, labor abundant area, and considered that the opening effects would be conditioned by these circumstances, raising the demand for the relatively abundant factor of production, and might have expected major expansions in the production and exports of labor-intensive products. However, during the 1990s it became quite clear that this view of the region was incomplete and misleading. As economic liberalization arrived in the region followed a rapid growth of foreign investment and exports of natural resources, with a much more modest growth of labor-intensive manufacturing industries. This provides another channel through which natural resources matter; since South Ame

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