Economic reform and modernization in Latin America.

• Author: Edwards, Sebastian

Latin America entered the era following World War II with great optimism. International reserves were at record levels, an incipient manufacturing sector was beginning to develop vigorously, and there was an almost unlimited faith in the ability of government policies to secure growth and cure social ills. The creation of the Bretton Woods institutions generated expectations of a stable international economic environment, free of the financial and payments crises that had afflicted the region for many decades. Starting in the mid-1940s, most Latin American countries followed a development strategy based on a high degree of protectionism, government-led industrialization, and a broad involvement of the state in economic activities. For some time, it seemed that this approach was working, and that early promises of growth and prosperity would materialize, allowing the Latin American countries to gradually move into the ranks of the more advanced nations.(1)

Between 1950 and 1980, Latin America grew at an annual average rate of almost 6 percent per annum, significantly faster than the industrial nations, and only marginally slower than the East Asian countries.(2) However, a number of disturbing developments seriously and steadily undermined the long-term sustainability of the regional strategy. First, excessive protectionism and generalized government controls encouraged rent-seeking activities, and created a very rigid economic structure. Second, in many countries the combination of increasing burdens on public sector budgets and inefficient tax systems, and the government's reduced ability to provide social services efficiently, generated an increasing degree of inequality.(3) Third, as a result of weak structures of public finance, more and more countries were forced to rely on inflationary financing as a way to bridge government expenditures and revenues. And fourth, as a consequence of the inward-looking strategy, exports were greatly discouraged, barely growing between 1960 and 1980.

After the first oil shock of 1973, the mode of development followed by Latin America became increasingly unsustainable. The aggregate current account deficit for Latin America and the Caribbean more than doubled between 1972 and 1982, rising from 2.2 percent to 5.5 percent of GDP. Moreover, the region's foreign debt/GDP ratio increased from 0.20 in 1975 to 0.46 in 1982.(4)

The debt crisis unleashed in 1982, and the failure of policies put in place in some countries to deal with it--the Austral Plan in Argentina, the Cruzado Plan in Brazil, and the APRA Plan in Peru--played an important role in reshaping policy views in Latin America.(5) It became increasingly apparent that the high degree of reliance on the state to run the economy had not produced the expected results. Instead of protecting the public from major external shocks, the overexpanded state had greatly weakened the ability of these economies to react to foreign disturbances. Politicians and policymakers began to sense--slowly at first, and then at an increasing speed--that the inward-oriented policies followed by the majority of the region were no longer sustainable. As the 1980s unfolded, economists dealing with Latin America with increasing insistence recommended a shift in the region's development strategy toward market-based policies. At the end of the 1980s, a growing number of political leaders began to adopt a new vision of economic policy based on market forces, international competition, and a greatly reduced role for the state in economic affairs. After 1989, there was an intensification and generalization of this reform process, with more and more countries opening to international trade and embarking on ambitious privatization programs. In the early 1990s, policy-makers in an increasing number of countries began to supplement the modernization reforms with social programs focused on the reduction of inequality and the eradication of poverty.

Latin America's experience with adjustment and market-oriented reforms during 1982-92 has been fascinating, and has generated successes as well as failures. In many cases, the reforms are too recent to draw firm conclusions on their outcomes, but in others there is already enough evidence to provide at least an initial evaluation.(6)

1. The Debt Crisis and the Muddling-Through Period: 1982-7

   The debt crisis erupted rather unexpectedly in August of 1982.(7) Initially most analysts, including those in the multilateral institutions, argued that Latin America was facing a mere liquidity problem. The early years of the crisis were characterized by an emergency adjustment process in which countries had to improvise in an effort to rapidly generate massive resource transfers to the advanced world. During this early period, a number of countries--Argentina, Brazil, and Peru--experimented with heterodox plans that ignored the need for fiscal discipline, as a way of reducing inflation. These programs were the last massive adjustment effort based on the traditional Latin American structuralist approach to economic development. Their rapid failure ignited a deep soul-searching process among political leaders and intellectuals in the region.(8)

   Since 1987-8, there has been remarkable transformation in economic thinking in Latin America. Protectionism and interventionist views have given way to openness, market orientation, and competition. There have been four main causes behind this doctrinal transformation: first, the realization that the traditional government-led development policies had failed to create a modern economic system; second, the example of the countries of East Asia...