S. Edwards

Chapter 2 (Muddling through: Adjustment from 1982 to 1987)

Chapter 3 (The emergence of a new Latin American Consensus)

A Summary 

In a Nutshell

The ISI programs and debt explosions (LT debt quadrupled from $45.2bn to $176bn between 1975-82, and total debt in 1982 was at $333bn) were bound to require adjustment and that came in the form of the Mexican debt crisis which quickly spread to the other countries of LA. The crisis was the product of both external (increased IRs, slow growth in the industrialized world leading to fewer exports, oil shocks and consequent lending, overvalued currency leading to capital flight in speculation against the domestic currency) and domestic factors (macroeconomic disequilibria, overvalued ex rate, inefficient industry).  In response to the crisis new models were sought, and the transition democracies chose heterodox solutions which stabilized inflation and prices briefly but its failure to tackle the underlying structural and fiscal problems meant these packages were doomed to failure. At this point of renewed frustration the free-market reforms advocated by Washington etc. provided an alternative, although the intellectual and public support for those programs had begun before the conditionality programs of loans were made by the IFIs. There were in fact three main factors that lead to the adoption of the free-market reforms: the East Asian miracle was looked to as a model of growth; the example of Chile once the newly democratic government made it clear they would largely continue the free-market policies brought in by Pinochet; the influence of the IFIs.

 The Mexican Crisis and Latin American Response

  • Looking at debt spreads the author suggests the August 1982 crisis was not anticipated . Once the crisis set in the spreads were large and volatile reflecting the chaos of the end of the Portillo administration (nationalizing banks, suspension of debt payments). Things calmed down with the new austerity measures introduced by the Madrid government. In 1983 negotiations with the IMF paid off and the debt was rescheduled. 
  • Once the Mexican government announced it could not meet obligations new funds were dramatically reduced (up to 40%). Even countries who were stable macoeconomically such as Colombia were affected by the reduction in lending. Net transfers of resources went from being negative to strongly positive ($12bn p.a.)
  • The region was forced to reverse the current account deficit. Between 1982-86 the region as a whole went from -$2bn deficit to more than $39bn surplus! They achieved this by contractions in imports and investments. On the import side this was mainly intermediate and capital goods which restricted possibilities for investment and domestic production(exchange rate control, capital controls and quotas were the tools). On the investment side it was largely infrastructure and construction that was cut. The policies were for short-term effectiveness without much thought for welfare.

  Expenditure reducing policies

  • Reduced public investment
  • Severe control of public sector wages despite inflation
  • Borrowing from national banks in response to less credit crowded out private borrowing and kept investment in check.
  • Mex, Uruguay and Ven all cut public expenditure by around 20%

 Expenditure switching policies

  • Import restrictions
  • Nominal devaluations
  • Import tariff hikes (at least initially)
  • The author states that quantitative restrictions of this sort can be justified only as a means of establishing credibly the willingness to adjust the macroeconomic position, but only in the very short-run. In the long-run they hurt the economy e.g. Mexico where extensive restrictions between 1982-84 cut intermediate good imports thus reducing the prospects for future growth.
  • 1986 saw some relaxing of restraints e.g. Chile reduced tariffs to a uniform 20%

 Despite the valiant efforts of the LA countries the trade surpluses continued to fall short of the interest payments. Gradually it was realized that countries in crisis in LA needed an increase in new money (!!!) to kick start growth that would allow for sustainable policies [and a means to conditionality for the IFIs] and this became part of the accepted thinking with the 1989 Brady Plan.

 Heterodox Stabilization of the Mid-1980s

  • Heterodox solutions to hyperinflation occurred in Arg, Brazil and Peru. These policies emphasize price control and deemphasize demand management and fiscal discipline.
  • Some argue they were really designed to strengthen government role. They were seen as alternatives to plans based on free-markets and restraint and as such they were a final attempt to develop with the government still taking a dominant role.

 Argentina’s Austral Plan

  • June 1985.
  • Price and wage freezes
  • Fiscal adjustment to correct deficit (increase in cost of public services to achieve this)
  • Monetary reform.
  • Initially worked well to reduce inflation. But price of services increased in real terms thus leading the state to lose control of deficit they previously had corrected as they had frozen the prices at an albeit higher level than previously.
  • Once deficit and inflation began to climb again the Alfonsin government was ushered in an they took steps toward liberalization.

 Brazil Cruzado Plan

  • President Sarney Feb 1986
  • Similar plan but less emphasis on fiscal correction.
  • Demand rose to levels inconsistent with price freeze so there was disequilibria, shortage etc. Fiscal imbalance put further strain on the economy.
  • Eventual collapse left Brazil with even higher inflation.

 Mexican heterodoxy

  • Under Madrid administration was more successful due to mix of income policies with credit and fiscal restraint. In other words they tried to address some of the underlying problems. Additionally the fiscal problems were brought under control before the income policies were enacted unlike in Arg.
  • Also the plan was part of a larger modernization strategy including deregulation and opening of the economy.
  • There was more social support in Mex.

 As a result of the failures of heterodoxy the region looked for a new paradigm.

 The New Paradigm

  • Away from state interventionism, inward orientation and macroeconomic imbalance and toward competition, market orientation and openness. There was also a drive to redefine the role of the state. Now an effective strong state was sought, not an interventionist state.
  • Perez in Ven
  • Menem in Arg
  • Gaviria of Colombia
  • Fujimori of Peru all supported market-based reform.
  • The transformation of views was due to a variety of factors: failure of heterodoxy and sense that state-based development models had worn out their use (ISI). In some ways heterodoxy was government intervention’s last chance to show its relevance in a globalized world and it failed miserably. The propagation of the ideas was made possible by high level alliances between technocrats and politicians.

 East Asian Experience

LA (and the IFIs) looked to EA to see why they had had such sustained economic success when LA had failed given that in the period 1965-80 they were growing at similarly healthy rates of 6/7% p.a. Four policy differences were advanced:

  1. EA avoided excessive and variable protectionist policies
  2. EA stayed away from overvalued currency
  3. EA maintained macroeconomic environment with steady inflation
  4. EA had fewer regulations in almost all commercial spheres.
  • e.g. Korea – merchandise exports grew at 23% p.a. between 1963-90. But in years 1950-63 the external sector was highly distorted due to ISI policies. It was a “highly repressed economy” in this period. In 63/64 they began to look outward – human capital accumulation, currency devaluation, gradual tariff reduction, import prohibitions eliminated, export encouraging programs implemented, competitive currency rates maintained. They were more flexible with policy than LA. When a policy was not working to increase exports it was binned, plus export subsidies etc. were given in a competitive manner – if the company did not perform the subsidy was not removed. So they did not have the same rent seeking aspect as the LA experience.
  • However there are great differences between the regions: inflation much greater in LA and ex rates more volatile. Politics and income distribution may have also played a part in the differences: in EA an overvalued currency hurt a huge number of producers of tradable goods in the rural sector. In LA an overvalued currency only affected a small number of often absent large landowners [why?], so the political costs of an overvalued currency were much greater in EA. [Also the factor mix was different. EA was abundant in labour and LA in land. Both were “backward”. This predicts different patterns of support and resistance to trade opening. See notes on Rogowski Coalitions]

 Chile as Role Model

  • Chile was looked to as a role model especially after the democratic government said it would continue to pursue the Pinochet reforms.

 Role on IFIs

  • Influenced the propagation of ideas through empirical research(many papers on EA comparison, on the benefits between trade restrictions and poor growth etc.), sector analysis, lending practices etc.
  • In terms of the lending practices the LA authorities were forced in some cases to implement reforms due to conditional release of funds by the IFIs. The author notes they often went further than the IFIs had suggested. E.g. see Grindle

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: