Conclusions

This paper has provided data on a number of dimensions for comparing the financial markets in Latin America and East Asia. They can be summarized in the following six points.

• The overall financial sector – including banks as well as capital markets – is much deeper (when measured as a share of GDP) in East Asia than in Latin America, and the gap has been growing. While Latin America's capital market segment (bonds and stocks) has been expanding faster, it still has not caught up.
• Banks claims as a share of GDP actually contracted in Latin America during the 1990s, in the presence of a serious credit crunch in a number of countries during the last half of the decade, while they boomed in East Asia. Of equal importance, a much higher share goes to the private sector.
• The bond market presents a slightly more balanced picture. Both regions saw bonds outstanding double between 1990 and 2001, but as a share of GDP the market was larger in Asia. Again, a much higher share was captured by the private sector in Asia.
• Stock market capitalization has grown rapidly in both regions, although new issues have fallen off substantially. In addition, the number of listed firms has fallen in Latin America, while it doubled in East Asia over the decade. East Asia's markets are also more active in terms of trading volume.
• While Latin America lags behind East Asia in the domestic financial markets, this is partially offset by its greater participation in international markets. The share of international finance in total finance is almost twice as high in Latin America as in Asia.
• Finally, on all of the indicators above, there is great diversity across individual countries in the two regions. Indeed, in many cases, intra-regional differences are about as important as inter-regional ones.³¹

The greater depth of the markets in East Asia can be explained by several factors. One is the region's superior macroeconomic performance (higher growth rates, lower inflation, and higher savings) since the early 1960s. Another is the traditional structural links between banks, governments, and firms. A third is government policies toward financial markets. While Latin America has indirectly promoted capital markets through the privatization of its pension system, thus creating a strong pool of institutional investors, East Asian governments have concentrated on legal changes and improved corporate governance. Latin America’s greater participation in international capital markets has provided some important benefits in getting access to deeper markets and lower prices, but it involves high risks in terms of volatility, exchange-rate risk, and possible contagion in times of financial crisis. All of these factors suggest that, insofar as evidence is increasingly pointing to finance as an important determinant of economic growth, East Asia after the financial crisis of 1997-98 is again poised to outperform Latin America in the years ahead.

In both regions, there is scope for increasing the strength of the capital markets, and governments have recognized this as a goal. A number of policy measures are on the agenda; there is broad agreement on some, while others generate more debate. The first group includes a strong legal system to protect property rights, better corporate governance and transparency, improvements in market infrastructure, benchmark government issues, and liquid secondary markets which implies the need for more investors (households as well as institutional investors). The more controversial proposals include the use of indexed securities, the role of foreign investors in local markets, and the policies for promoting institutional investors. In particular, controversy surrounds the privatization of pension systems, which has been the most effective way to stimulate institutional investors.³²

If local capital markets were to increase in importance, to what extent would they really be able to substitute for international market participation? Ironically, East Asia – which already obtains 90% of its finance locally, compared to 80% in Latin America – is more concerned about the issue. The main problems are the small size of the local capital markets in all emerging economies and thus their high volatility. It is hard to imagine that governments and large corporations can satisfy their needs in small local markets, although the latter are a help to these borrowers and virtually the only option for smaller firms. It is certainly a desirable option to strengthen capital markets in addition to upgrading the banking sector. As we pointed out earlier, the two should not be seen as substitutes, but complements.

In addition, however, two other sets of policy measures are complementary to both. One concerns regional markets and regional financial integration. This topic is high on the agenda in Asia. The financial crisis stimulated Japan to propose an "Asian Monetary Fund" to help provide liquidity to regional economies. Although this proposal, like an earlier one by Malaysian Prime Minister Mahathir for an "East Asian Economic Caucus," was shelved because of opposition from western countries and international financial institutions, other similar options continue to be pursued. The Chiang Mai Initiative of 2000 provided for swaps of local currencies in times of need, and the recent Thai initiative for a regional bond fund is part of the same agenda. While recognizing the enormous problems that would have to be overcome before Asia could follow Europe's trajectory to a single currency, small steps are being taken.³³ In Latin America, trade integration has taken priority over financial integration, in part because of the macroeconomic volatility in many countries. Recently, however, calls for macroeconomic coordination as a prerequisite for later discussion of financial integration have emerged within all of the regional trade groupings.³⁴

Of greater interest in Latin America is a second set of policy measures to deal with problems of international capital markets. These are the highly controversial use of controls on incoming capital flows to moderate the surges and droughts discussed earlier. Such measures also try to lengthen the maturity of capital inflows, since short-term flows have proven to be the most problematic. Chile took the lead in implementing such controls in the early and mid-1990s, but other countries (including Brazil and Colombia) followed similar goals with slightly different policy instruments.³⁵ The governments concerned believed that the measures were useful in dealing with problems during periods of capital surges; at the moment, of course, the problem is lack of flows, so this option is not immediately relevant.

The most important lessons to be drawn from the experience of Latin America and East Asia with respect to the financial sector in general, and the capital markets in particular, is the need to pursue a pragmatic mix of policies. There is no one solution. Just as both banks and capital markets should be simultaneously strengthened, likewise local and regional options can also be complementary. And, given that participation in international capital markets is sure to continue, policies to maximize the benefits and minimize the risks are an additional element of such a policy package. Each of the regions has relevant experiences that would be useful for the other. Future joint research in the area of finance would be an important contribution.