Category Archives: The Free Market Reformation

What was the washington Consensus?

CRISIS AND REFORM IN LATIN AMERICA

CRISIS AND REFORM IN LATIN AMERICA: FROM DESPAIR TO HOPE

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
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LATIN AMERICAN ADJUSTMENT: HOW MUCH HAS HAPPENED?

LATIN AMERICAN ADJUSTMENT: HOW MUCH HAS HAPPENED?

J. Williamson (ed.)

Chapter 2 (What Washington Means by Policy Reform)

A Summary 

In a Nutshell
This is the excerpt in which JW defines the Washington Consensus. What is remarkable is that the consensus is not half as specific as the subsequent literature makes out. Additionally although the consensus seems to be broad it is by no means ubiquitous in that there are points of disagreement and the author has different opinions to those of the IFIs at times. Most importantly it does not readily identify with what came to be known as neo-liberalism in that it is not itself a doctrine for how a country should develop its economic, political nor social life and policy. Rather it is a handful of specific recommendations for stabilizing crisis economies. The author even states that Washington is unsure if its recommendations are good for kick-starting growth – they are a tool for stabilization, not a long-term growth strategy. At times it is very specific, and at times very vague. Rather weirdly they do not take into account the welfare distribution of the effects of the policy (although they do take into account the effects they may have on corruption!) and this could be seen as a limitation: JW later said they should be supplemented with pro-poor redistributive policies. The key takeaway is that the WC is comprised of “policy instruments rather than objectives or outcomes”.

 There are 10 broad recommendations: 

  1. Fiscal deficits
  • IMF had long made fiscal control an element of conditionality.
  • Differences of view however on whether fiscal discipline need imply a balanced budget
  • A deficit of more than 2% is evidence of policy failure. 

     2. Public Expenditure Priorities

  • Reducing expenditures preferable to raising taxes.
  • Subsidies should be cut
  • Increased investment in human capital such as education and health. This helps disadvantage and gives a return to the state.
  • Public infrastructure investment also important.
  • In other words, away from wasteful subsidies etc. toward investment that can bring returns.

 

       3.Tax Reform

  • Broaden the base, and keep marginal rates low

      4. Interest Rates

  • Market determined
  • Positive to discourage capital flight

       5. Exchange Rate

  • Achieving a competitive rate more important than how it is determined. It is crucial as an element of outward looking policies.

      6. Trade Policy

  • Limited tariffs 10-20% to still help developing industries to a certain extent without hurting too drastically the economy.
  • End to import licensing
  • Not expected to occur overnight.

       7. FDI

  • Restricting FDI is silly 

       8. Privatization

  • Relieves budget pressures and increases effectiveness of enterprises

     9. Deregulation

    10. Property Rights.

‘Paradigm found: In Search for the Washington Consensus’

Panizza, Francisco E. (2008) ‘Paradigm found: In Search for the Washington Consensus’ (manuscript)

A Summary 

In a Nutshell

The Washington Consensus was not (initially) an overarching doctrine of how a country should manage its economic nor political life. Rather it was a set of specific recommendations on how to tackle large deficits and hyperinflation. However it became part of the neoliberal “doctrine” and here it was expanded upon to reflect the beliefs of the liberals in markets. This doctrine became the dominant one on LA largely in response to crisis and as a means of turning away from what had come before. As ISI came to the end of its usefulness, the authoritarian regimes that were in power began to move away from the structuralist model but it was too late to prevent crisis. The crises in part lead to the downfall of those military regimes, but the heterodox solutions that the new democracies introduced only served (eventually) to aggravate the situation. The neoliberal model was pursued by LA governments in response to these constant failures. As such, Panizza is arguing that the reforms proposed by the Washington Consensus were not merely imposed upon LA due to their weak governments, nor because of bullying tactics from the IFIs (although he concedes their influence was great), but rather they were chosen as a rational response to crisis. 

What was the Washington Consensus?

  • Neoliberalism and the WC are now thought to go hand in hand. But Panizza shows that the former is a much wider concept.
  • WC was a list of policy prescriptions outlined by John Williamson  (JW) in Latin American Adjustment: How much has happened? that embodied the thinking of the economists of the time (esp. in USA). There were 10 main prescriptions:
  1. Fiscal Discipline
  2. Redirect public spending toward health/education/infrastructure i.e. that offer high economic returns and can improve income distribution
  3. Tax reform (broaden base, and cut marginal rates)
  4. Interest rate liberalization
  5. Competitive exchange rate
  6. Trade liberalization
  7. Liberalisation of FDI
  8. Privatisation
  9. Deregulation (barriers to entry)
  10. Secure property rights
  • The key for development was to emulate the market-oriented policies of the developed economies, and the evidence for this was the growth of new Asia.
  • It was a plan for stabilisation not necessarily a plan for long term growth management. Critically it does not distinguish between the best form of capitalism model; Anglo-Saxon, EU social market, Japanese corporate capitalism. It makes no claims about markets and trade in terms of welfare (JW later said the proposals should be supplemented with a PRS). It does not give “blind faith in markets” centre stage (JW).
  • Some prescriptions were very precise (deficit of no more than 2% /  Privatisation), some were e very vague (reduce tariffs to between 10 -20% in 5-10 years). 
  • Neoliberalism (NL)on the other hand is not just about the economy. It is a social, moral and political discourse. Based on British liberalism: freedom to pursue rational self-interest and competition  as main source of innovation and growth. 
  • WC was a set of codified policy agendas, BUT it had sufficient “surplus of meaning” that it could be re-interpreted, as it was so but the NLs. 

ISI

  • NL gained it hegemonic position due to its contrast with the directed economics of the ISI period.
  • ISI was born in ECLAC in the “structuralist economic doctrines” that said that developing nations had to travel a different path of development to the already developed economies, as their infant industries had no protection from competition unlike those of the developed world when they were developing. If industry was not protected they would be condemned to being agro exporters and resource providers (comparatively cheaper than industrial goods produced by the core).
  • Used currency overvaluation and tariffs to spur on home industry. Deficits and inflation were accepted consequences.
  • The state was the gatekeeper of the national interest (protect from threat of competition).
  • ISI had broad social base (Middle class in the large civil service, urban workers with higher wages, industrialists, elites who could be rewarded with industrial patronage by the state) although there were losers (peasant farmers, consumers).
  • But sectoral/individual gains began to become built-in prerogatives. This was aggravated in 60s and 70s when growth slowed, fiscal crises abounded, and inflation shot up. The result was the authoritarian attempt to dismantle ISI 

Dismantling ISI

  • On the left dependency theory claimed that LA should cut itself off from the market as being connected could only ever keep it underdeveloped due to the chain of exploitation starting in the core and spreading to the periphery.
  • On the right, free market ideas gained traction as it became ever more costly to mediate the problems caused by ISI. Monetarism (later to be called NL) was part of a narrow economic debate on how to solve bop and inflation problems. Inflation was a monetary problem caused by deficit and overexpansion of credit. This contrast with structuralist view that inflation was reversible using structural reforms to bring more people in the economy thus expanding the industrial base.
  • There was an overlapping political debate about spending and distribution. Monetarists wanted austerity, but sturcturalists said austerity caused recessions. 
  • 60s-80s no one narrative could dominate, rather there was a complex process of change. Elements of ISI were dismantled, or deepened depending on the country specific political/economic realities. Change was influenced by many factors including availability of financial resources to fund ISI (oil rents etc.) as well as political factors (how the government/elites dealt with popular protest etc.).
  • Chile was one of the first to dismantle ISI under Pinochet. This was in part a political move – the technocratic policies of monetarism excluded the working classes, and prevented the distributive struggles that were a breeding ground for socialism and the left in general. 
  • Internal contradictions in the military regimes of LA in the period prevented them from founding a true new political and economic order. 
  • Dismantling was uneven in the region:
  • e.g. Arg: rapid reduction of tariffs decimated local industry (weakening the Peronist working class – a benefit for the military). Tariffs still very high relative to the rest of the world. State reform was very limited and fiscal austerity was abandoned in the late 70s. In 80s recession tax revenue was eroded and resulted in large deficits as inflation reached 310% in 1983 (last year of military rule)
  • In Brazil, Mexico and Peru the 70s and 80s saw a deepening of state-led model. E.g. brazil had growth of 7.4% and industry was growing with low inflation.
  • E.g. Same for Mexico but it had a tight control over public spending. However with the rise of Echeverria (70-76) public spending was increased and deficit funded by borrowing. The increased borrowing and deficit and eventual capital flight lead to devaluation and financial crisis when external funding dried up in late 70s. Debt crisis of 1982! 
  • The 1982 crisis represented a watershed. Economic policy options narrowed and there was a paradigm shift that unshed in the hegemony of free market economics.

 Neoliberal Hegemony

  • The dominant ideas of IS had become discredited and the crisis weakened the elite’s ability to maintain the status quo (Olson). There was a new possibility of change (although direction was still unclear). NL did not become totally dominant until the late 80s.
  • Ideological shift was part of worldwide pattern following end of post war growth period, inflation and recession that lead to focus on the UK-US laissez-faire model. Additionally forces of globalization were become unstoppably strong. But this is not enough for Panizza to explain how NL became part of LA.
  • NL reforms were chosen by democratic states (except in Chile). So pressure from IMF etc. (although great) and worldwide trends, are not sufficient to explain why they were adopted in LA.

 

  • NL was part of the maturing of democracy in the region. When democracy was nascent in LA, liberal reforms were associated with the military regimes. Public debate about democracy focused on human rights etc. not on economics. So with the first elected presidents we do not see the introduction of NL reforms. Rather, reforms were heterodox
  • e.g. Peru. President Terry had tried liberal reforms (80-85) but there was much resistance. His successor Alan Garcia (85-90) returned to state led heterodoxy e.g. price freezes, wage increases, more spending financed by reduction in debt servicing. The result was hyperinflation.
  • e.g. Bolivia went democratic in 1982 with Siles Suazo at the head. He also used heterodox methods and they too failed to combat inflation. His successor Estenssoro then introduced a radical free market reform package.
  • In general the Heterodox solutions caused hyperinflation which obliterated livelihoods and jobs. There was a concomitant breakdown in social order and thus political order. The state could no longer regulate social relations and there were mass protests.

 

  • It was now a question of assigning responsibility for the crises. The problem was both old and new. New as it represented problems specific to the 80s (debt crisis, oil shocks etc.) and old as it was the result of deeper long term problems rooted in ISI. However, it was now argued by free-market adherents that the 80s crisis could not be overcome simply by fiscal adjustment packages and so the WC became a much wider NL economic and political reform agenda. There would have to be a wholesale reform of the relationship between citizen and state 
  • Alfonsin in Arg having implemented heterodox packages now turned around and sought to liberalise. It was too late though to stabilize the economy, and the political outsider Menem came to the fore and implemented wide ranging reforms [see Grindle from EH451]
  • Collor came to power in brazil on a similar mandate.
  • Mexico did not suffer such a huge turnaround – rather reform was more gradual
  • So NL’s rise was founded in the failure of the new democratic administrations in the 80s to deliver a better life and thus a change occurred in the relationship between democracy and free-market economics (as it was previously associated with military dictatorships as being the only governments powerful enough to force through such reforms). NL offered d a clear diagnosis and prescription. “In this new political context economic liberalism’s mistrust of the state and ultimately of politics, resonated with popular disillusionment with failed promises of a better life under democracy”.

Silent Revolution

THE SILENT REVOLUTION

Duncan Green

Chapters 1,3,4

A Summary

 

The first chapter is largely about ISI and it failures. It adds nothing new to my understanding. Like others he sees IS as a response to the crash in 1929 bringing the free-trade to an end and brought in ISI based on Keynes. It went hand in hand with populism which preferred to print money rather than take difficult distributive decisions. He emphasises the benefits of ISI including the raised life expectancy and literacy indicators as well as urban development (albeit with lots of inequality). Also it broadened political inclusion with the insertion of the working class into political life. But whilst EA countries successfully transitioned away from ISI, in LA they could not. This resulted in poor products, a two tier labour force, a continued reliance on imported capital goods etc. meaning that the trade deficit was not actually remedied. There was still huge inequality. Tariffs hurt the rural sector as capital good were expensive to import and overvalued currency made export uncompetitive. This lead to a large migration to urban centres.

As the flaws became apparent in the 60, governments tried to modify their policies.

He has a traditional line on debt: petro$s increased investment etc. and this was embraced by the neoliberal authoritarian regimes that also liberalized trade and caused de-industrialisation in e.g. Arg. He emphasises that ISI and huge debt do not necessarily go hand in hand e.g. Korea and EA countries who managed debt well.

 How did Neoliberalism Come to Dominate?

  • Support of local economists (Chicago university program in Chile)
  • Pre-existing crises in ISI
  • Lack of alternatives
  • Green is bemused at the rise of the technocrat which he sees as pivotal in the acceptance of the free-market reforms. He advocates Ha-Joon Chang’s historical approach to finding patterns and seeking their explanation rather than relying on abstract theory based on barely plausible assumptions. There is too much emphasis on mathematics and not enough on real life situations and people. He states rightly in my view that maths does not mean objectivity. Indeed decisions about policy always contain political choices about the rival merits of state and market and the role the state should play in people’s lives. He argues that replacing the state with the market disenfranchises people when pressure groups and individuals have learnt how to lobby the state in a certain way. In order to get the same influence over policy they would have to acquire influence over large corporations etc. [This seems pretty farfetched. Given the fluctuations between democracy and authoritarianism I doubt very much pressure groups knew if they were coming or going]
  • He argues that it could be that neoliberalism is more political than economic as it was designed as a counterfoil to the rise of communism – it was part of a battle for ideas not a serious map of where a country should aim to go.

 The Lost Decade

  • Green focuses on the human cost on liberalization: falling wages, rising inequality, redundancy, an increase in families below the poverty line, (a staggering 80.1% in Bolivia in 1991), breaking of the unions, de-industrialisation, bankruptcy etc.
  • The genesis of the reforms was found clearly in the recession of 1982-83 caused by sudden end to lending by the commercial banks. Now LA was exporting capital rather than importing. The could either declare a debt moratorium or generate trade surplus, so they did the latter. As exports were already depressed due to the overvalued currency and focus on inward development, this surplus could only come from import suppression i.e. stop the citizens consuming – this means devaluation and recession.
  • The rules of the debt game meant it kept increasing even while the population suffered. Payments that might have been used to purchase imports instead went to debt service.
  • He interprets the lack of domestic investment as a consequence of the capital exporting to service the debt, rather than a deliberate policy choice (unlike S. Edwards). It was more politically expedient to cut investment than sack employees although they did that too. “The level of investment is crucial to any economy’s prospects: Latin America was mortgaging its people’s future to pay its debts.”
  • There was the additional problem of turning the trade surplus into debt service payments as a large slice of the export income dollars was in private hands. In some cases the government was forced to print money to purchase the forex causing renewed inflation. If they did not, they had to tempt exporters to invest in government bonds with high interest which only lead to more debt, this time domestic.
  • Even despite the cuts, the devaluation and increasing cost of debt meant that deficits grew and grew and even the largest governments printed money with resulting hyperinflation.

 The False Dawn

  • There was a return to growth in 1984 but this was mainly due to Brazil’s Sarney government raising wages in a “growth first” policy framework that brought growth to 8% aided by restrictions on its debt service payments.
  • By 1985 there were doubts over the IMF style stabilisation. The result was heterodox solutions to managing inflationary expectations using freezes on wages, ex rates and prices. They are supposed to be a cooling off period in which time the government can deal with the underlying problems. However the deficits etc. were not dealt with, and the short term boom lead to a surge in consumption, but this could not be sustained and inflation made a fierce comeback as the plans failed.
  • 1984-87 saw the gradual shift toward the export-led growth model and trade liberalization that would be ubiquitous by the end of the decade. Whilst this saw imports increase investment was still stagnant and this may have laid the foundations for continued underperformance in the region.
  • The debt service “hemorrhage” continued to the detriment of healthcare and education etc. All public services suffered “the social and economic fabric of Latin America was falling apart”.

 

Social Impact of the Lost Decade

  • Up to 1980 % living in poverty had been falling. The welfare indicators had been rising (see Astorga et. Al). In 1980s 64 million new names were added to the list of the poor. There was hunger, disease and despair.
  • Lower wages, greater insecurity and steep price hikes for food basics. Meanwhile TV flooded the continent showing flashy American lifestyles leading to the dispossessed men turning to alcohol and rage causing family breakdown, crime and social disintegration.

 [What is interesting is the totally different way Green looks at the reforms. He looks to the human consequences rather than just the economic justifications or stabilisation successes. What we have to wonder though is how much of this was due to the popular mandate i.e. in the post crisis world (wherever the blame lies for the increased debt etc.), where hyperinflation was destroying wages and savings, did the people sign up for the reforms at any cost? Were the costs greater than they anticipated? Why did some governments go further than they were required to? (Weyland).]  

 Investment, Growth and Development

  • Capital inflows resumed in 1991 albeit in forms other than purely commercial loans: equity purchases, bond purchases, bank loans to LA companies, FDI in farms, factories and service industries.
  • Total debt began to rise again –by 1999 it had reached $762bn for the region.
  • But the new money dried up just like it had in the 80s and thus we had the 1994 Mexico crash. The liberalized financial markets meant investors could pour money into Mexico, but they could just as easily whip it out – so there was considerable flight risk. As every the taxpayer had to pick up the bill for bailing out the banks.
  • The capital had flowed in and had been sucked up as a new option in cushioning from the worst effects of the liberal adjustment. The capital inflows meant that the debt could be serviced and the economy restructured. Moreover it meant the currency could be kept strong thus curbing inflation by keeping import prices low. The consequence of course was trade deficit, but even this could be funded by the capital inflows, as long as they lasted.
  • However, once again LA was at the mercy of external events. The U.S IR rises of 1994 meant that Mexican bonds were no longer so desirable. There was political turmoil in that year too (Zapatista uprising) and investors lost confidence.
  • Brazil was next, the contagion had spread despite the relative health of Brazil. Investors pulled out $30bn in two months.
  • Then it spread to Argentina.
  • All three governments were forced into sudden devaluations. Argentina was worst hit, with large scale government cuts and $-denominated bank account freezes. This cause political and social chaos. Urban unemployment in Mex doubled. Brazil had 0 growth and 25% unemployment.

 Lessons for the Future

  • “Reliance on the fools’ gold of fickle capital inflows made the region vulnerable both to events beyond its control, such as the Asia crisis of 1998, and to the received wisdom of the markets.” If investors were not happy, they just pulled out.
  • “The main lesson is that capital account liberalization is not the answer to LA’s historical inability to save and invest sufficient quantities to generate growth and jobs.”
  • $isation of the currency can be an option for smaller countries.
  • FDI is better than other types of capital as it is sticky.