TRADE: In the Midst of an Economic Crisis

Article excerpt

Sharp contraction in the U.S. economy has hit Latin America where it hurts the most: in shrinking trade volumes. The socalled "vacuum cleaner effect," or, the drying up of liquidity resulting from the collapse in U.S. credit markets, combined with decreased aggregate demand, has affected even the best-managed economies.

The result is no surprise: falling trade numbers from around the region. Brazil's imports in February 2009 fell a whopping 34.6 percent and its exports dropped 25.1 percent year-on-year-a stark contrast with the 44 percent increase in imports in 2008. In Chile, where lower copper prices had already flattened trade in 2008, exports collapsed by 41.3 percent in January, and imports shrank by 25.5 percent. Mexico, similarly, reported sharp reductions in total trade at the end of 2008 and in January 2009.

Lower trade volumes are not limited to Latin America, of course. They are a global phenomenon that reflect a fall in demand and the disappearance of trade credit. This lack of credit has a negative impact on short-term trade flows, but the more permanent and damaging effect comes from the lower demand of developed-country economies. And while it is hard to make concrete predictions, it is likely that Latin American economies will suffer more from decreased export volumes and lower export prices than from reduced imports.

In sharp contrast with the U.S., where financial difficulties and deleveraging reduce consumption and investment, the main impact on many Latin American countries comes through lowered exports and reduced foreign direct investment (FDI). The fall in U.S. absorption (consumption and investment) results in a reduction of the U.S. trade and current account deficits, but in Latin America it produces the opposite: a move toward a larger current account deficit and more difficulties in its financing. This means that in 2009 we can expect to see a sharp decline in Latin American export earnings either due to worsening terms-of-trade for commodity exporters or to significantly lower trade volumes.

Latin American countries will have to choose from a menu of unappetizing policy measures to deal with the fall in aggregate demand and the difficulties in financing current account deficits. The four likely choices include: voluntary reduction of consumption, investment or government spending; involuntary reduction of consumption and investment through currency depreciations; deployment of international central bank reserves; and improved country risk profile-through painful structural reforms-to reverse the fall in FDI and portfolio investment and avoid a sharp adjustment in employment and GDP growth. …