Editors' Summary

The brookings panel on Economic Activity held its seventy-sixth conference in Washington, D.C., on September 4 and 5, 2003. This issue of Brookings Papers on Economic Activity includes the papers and discussions presented at the conference. The first paper examines the Mexican economy since Mexico liberalized its financial markets and concludes that its disappointing performance is due, in important part, to inadequate domestic reforms. The second paper takes a fresh look at understanding the factors behind economic growth over the past forty years, using the experience of eighty-four countries at various stages of development. The third paper looks at how the U.S. productivity surge since the mid-1990s affects our understanding of productivity trends and cycles, and how this might inform future projections. The fourth paper looks for evidence of a bubble in current housing prices.

After Mexico liberalized its foreign trade and financial transactions beginning in the mid-1980s and joined the North American Free Trade Area (NAFTA) in 1994, it was widely expected that exports would boom, contributing to exceptional economic growth. These expectations have not been met. Mexico experienced a financial crisis in late 1994, from which it recovered with substantial help from the United States. Its exports did rise sharply but then stagnated along with GDP starting in 2001. And on average since liberalization began, Mexico's economic growth has been unexceptional. Mexico's experience, along with the financial crises that beset a wide range of other emerging market economies during the 1990s, raised a number of still-unsettled questions about the benefits and costs of financial liberalization. Although liberalization promoted the inflow of capital from abroad, aiding economic expansion, all too often that foreign capital flowed out just as freely, precipitating crises in some countries and contributing to them in others. In the first paper in this volume, Aaron Tornell, Frank Westermann, and Lorenza Martínez provide a new analysis of how liberalization affects emerging market economies. In their view, liberalization does promote growth by easing financial constraints. But in the process it adds to risk taking in the financial sector, which makes the economy more vulnerable to crisis. How much more risk, and how vulnerable the economy becomes, depend on the ability of lenders to enforce contracts with borrowers and on the prospects for a bailout of the banking sector should a financial crisis occur; these factors in turn depend on certain characteristics of domestic economic and legal institutions. The authors examine these ideas empirically and use the results to inform an extensive analysis of Mexico's recent experience.

The authors begin with an empirical model of the economic linkages among liberalization, financial fragility, and growth. They use a sample of fifty-two countries whose financial markets have achieved a certain level of development, as indicated by a minimum level of activity in their stock markets, and for which data are available for the period 1980-99. The countries are partitioned into seventeen that are judged to have a high degree of contract enforceability (high-enforceability countries, or HECs) and thirty-five that have medium contract enforceability (MECs). The HECs include the Group of Seven large industrial countries and ten others for which an index of the prevalence of the rule of law exceeds a threshold value; all had liberalized both their trade and their financial markets before the start of the sample period. Many of the MECs opened their markets during the sample period, and the authors date these openings by when a trend break occurs in the country's trade or capital flows or when the ratio of trade or capital flows to GDP exceeds a threshold value. The dates identified by this process are similar to those found by earlier researchers.

From these datings and from data on the economic performance of each country, the authors infer a number of stylized facts. One is that trade liberalization has typically preceded financial liberalization in MECs. Another is that both trade liberalization and financial liberalization are associated with faster GDP growth. This conclusion emerges from several specifications of both cross-sectional and panel regressions explaining growth in...