Chapter 15 Trade and Policy Reform in Latin America.

Chapter 15

Trade and Policy Reform

in Latin America

Learning Objectives

• Describe the strengths, weaknesses, and reasons for import substitution industrialization.

• Explain the strategy and performance of economic populism.

• Give the main reasons for the debt crisis of the 1980s and analyze its relationship to ISI.

Learning Objectives (cont.)

• Discuss the goals of economic policy reforms that began in the later 1980s.

• Explain why some Latin American leaders have become impatient with economic policy reforms.

Introduction: Defining a “Latin American” Economy

• A “Latin American” economy is considered “all of the Americas south of the United States” (Webster’s dictionary)

• However, Latin America is quite diverse, and one needs to be careful not to over-generalize

Population, Income, and Economic Growth

• For long stretches of the 20th century, Latin America was one of the fastest-growing regions of the world

• From 1900-1960 real GDP per capita grew at similar rates to Europe, U.S., or Asia

• The Debt Crisis turned the 1980s into a Lost Decade, as growth was negative, inflation skyrocketed, and poverty increased

TABLE 15.1 Population and GDP for Latin America and the Caribbean, 2010

TABLE 15.1 (continued) Population and GDP for Latin America and the Caribbean, 2010

Import Substitution Industrialization: Origins and Goals of ISI

• Economic policy reform in Latin America brought the demise of the economic development strategy known as import substitution industrialization (ISI)

• ISI shifts policies from outward, export orientation toward an inward, targeted industrial strategy

• ISI is a form of industrial policy that focuses on those industries that produce substitutes for imported goods

Import Substitution Industrialization: Origins and Goals of ISI (cont.)

• Terms of trade (TOT): (index of export prices)/(index of import prices)

• Argentine economist, Raul Prebisch and a German exile, Hans Singer argued that coffee, tin, copper, bananas, and other primary commodity exports would inevitably experience price declines relative to the prices paid for manufactured goods

Import Substitution Industrialization: Origins and Goals of ISI (cont.)

• In effect, Latin America would be marked by export pessimism—each unit of exports would earn a declining unit of imports

• ISI would boost industries that produce substitutes for imported goods

• Export pessimism formed the basis of orthodox economic policy from roughly the 1950s through the 1970s

Criticisms of Import Substitution Industrialization

• Government involvement in production decisions caused a misallocation of resources; not market failures as assumed

• Exchange rate overvaluation

• Policies were too biased in favor of urban areas

• ISI trade and competition policies were heavily protectionist and often favored the creation of domestic monopolies

• ISI fostered rent-seeking and corruption

Macroeconomic Instability and Economic Populism

• Many Latin America specialists blame faulty macroeconomic policies on populist or economic populist political movements

• Crises are often attributed to economic populism and populist policies: political movements using expansionary fiscal and monetary policies without regard of inflation risks, budget deficits, and foreign exchange constraints

Populism in Latin America: Three Conditions of Populism

• Deep dissatisfaction with the status quo (slow growth)

• Rejection of the traditional constraints of macro policy

• Promises to raise wages while freezing prices and restructuring the economy by expanding domestic production of imported goods

• “reactivating, redistributing, and restructuring”

Stages of Populist Policies

• Economic stimulus through government expenditures and printing money

• Creation of bottlenecks • Increase in prices and budget deficits/debt• Acceleration of inflation • Pervasive shortages become pervasive• Capital flight and decline in wages• Resort to IMF intervention

TABLE 15.2 Economic Indicators during the Garcia Administration

The Debt Crisis of the 1980s

Causes of the Debt Crisis:

•Collapse of world oil prices (Mexico particularly affected)

•Increase in international interest rates

•Longstanding political mismanagement

•High rates of lending in 1974–1982

TABLE 15.3 Debt Indicators at the Onset of the Debt Crisis, 1983

Responses to the Debt Crisis

• U.S. Treasury Secretary James Baker, 1985, tried to organize a renewed lending program by commercial banks through the Baker Plan

• U.S. Treasury Secretary Nicolas Brady engineered the Brady Plan in 1989: Latin American countries required to reform their economies to obtain debt relief

• Capital flows began to return to Latin America

Neoliberal Policy Reform and the Washington Consensus

• In the late 1980s, Latin America launched economic policy reforms that began to alter the fundamental relationships between business and government and between their national economy and the world.

– The region adopted a neoliberal model or neoliberalism favoring free markets and minimal government intervention in the economy

Neoliberal Policy Reform and the Washington Consensus (cont.)

Three Aspects of Neoliberal Reforms

•Implementation of stabilization plans to stop inflation and control budget deficits

•Privatization of state-owned enterprises

•Protectionist trade policies were abandoned

Neoliberal Policy Reform and the Washington Consensus (cont.)

• These reforms came to be known as the Washington Consensus on policy reform

• Both the neoliberal agenda and the Washington Consensus were considered policy prescriptions for reform of government finances and management of the economy

The “Washington Consensus”

• Macroeconomic reforms proposed by the Consensus:– Avoid large budget deficits

– Spend public money on health, education, and basic services

– Cut taxes, but tax a wider range of activities and improve collection

– Make certain real interest rates are positive; limit the use of preferential rates

– Make the exchange rate competitive and credible

The “Washington Consensus” (cont.)

• Microeconomic reforms proposed by the Consensus:

– Use tariffs instead of quotas, and gradually reduce them

– Encourage foreign direct investment– Privatize state enterprises in activities where

markets work– Remove the barriers to firm entry and eliminate

restrictions on competition– Guarantee the security of property rights

Stabilization Policies to Control Inflation

• Some Latin American countries adopted the orthodox model of cutting government spending, reforming the tax system, and limiting the creation of new money

• Others adopted the heterodox model: same as orthodox model but also included freezing of wages and prices

TABLE 15.4 Inflation Rates, 1982–1992

Structural Reform and Open Trade

• Structural reform policies include:

– The privatization of government-owned enterprises, deregulation and redesign of the regulatory

– Environment of overregulated industries such as financial services, and

– Reform of trade policy

Structural Reform and Open Trade (cont.)

• In 1970s Chile began to reform its trade policies

• In 1985 and 1986 Mexico and Bolivia followed

• In the late 1980s and early 1990s, nearly all the countries of Latin America began reducing both the level of tariffs and nontariff barriers (NTBs)

Structural Reform and Open Trade (cont.)

• The three main goals of trade reform:– To reduce the anti-export bias of trade

policies that favored production for domestic markets over production for foreign markets

– To raise the growth rate of productivity– To make consumers better off by lowering

the real cost of traded goods

Regional Trade Blocs in Latin America

• Latin America has many regional trade agreements; some of the oldest

• NAFTA was implemented January 1, 1994

• December ‘94, thirty-four countries in the Western Hemisphere committed to a Free Trade Area of the Americas (FTAA) no later than 2005

• By 2002, the FTAA idea was nearly dead, but Latin American countries have continued to sign bilateral and plurilateral agreements

TABLE 15.5 Average Tariff Rates, in Percents, Selected Countries

Table 15.6 Regional Trade Blocs

The Next Generation of Reforms

• Both Neoliberalism and Washington Consensus viewed negatively by many Latin American citizens

- reforms of the last two decades have created uncertainty and change

- have not begun to fulfill expectations of growth and prosperity.

• More moderate reformers developing a second generation of reforms

– take into account the region’s institutions– address the problems of social and economic inequality

The Next Generation of Reforms (cont.)

• Mechanisms for addressing Latin America’s highly unequal distribution of income

• Greater emphasis on primary education and health care for children

• A set of social policies called conditional cash transfers (CCT)

The Next Generation of Reforms (cont.)

• A few Latin American countries, including Mexico and Chile, have become the most open and outward oriented of countries anywhere

• Results elsewhere have been disappointing

Chapter 15 Trade and Policy Reform in Latin America.

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