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II. Politics and ideas in the eighties

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II. Politics and ideas in the eighties.
II.1. The political origins and the evolution of the MFA.
At least since 1982, the year of the Mexican moratorium, the Fund and the Bank have been intensively involved in stabilization and adjustment. Since the mid-eighties structural and policy reforms have been explicitly incorporated into the sets of conditions for adjustment lending. After more than two years of muddling through without any clear direction, the idea of taking advantage of the critical situation to promote modernization reforms that would restore growth, stated officially through the Baker initiative, was considered an important step forward and welcomed.

The initiative was intended to give a new "virtuous" character to the badly needed funds of the international agencies. On the one hand, the agencies, and therefore the American administration, were inevitably and significantly involved in the management of the debt crisis and in the rescue operations. In one way or another the agencies' available funds had to flow to the debtor countries as an essential element of the financial arrangement that followed the crisis. Besides, the governments of the region did not have many alternatives and were, as a consequence, in a particularly vulnerable position. The countries were starving for international currency, which increased their willingness to accept and promote the reforms favored by multilateral institutions and raised the leverage that lending conditionality had on domestic policy.

There was little time to think about the components of the modernization reform-package. The ingredients included in the recipe came from a variety of sources, although they shared a common flavor obviously akin to the more-free-market-less-state general orientation that was at the peak of its prestige in the American administration at that time. Trade liberalization had long been a preferred policy of the Bank. Financial liberalization and opening had been previously promoted by American advisors in other parts of the world and were also in fashion in the developed countries. It is worth mentioning again that both trade and financial reforms had been simultaneously implemented a few years before in Argentina, Chile and Uruguay, in the so-called Southern Cone liberalization experiences, with disastrous results. Even neoclassical economists were at that time formulating cautious assessments of those experiences and deriving policy recommendations full of warnings about gradualism and sequencing7, but little attention was paid to those caveats. Privatization was added a bit later, a component imported probably from the British Thatcherite cuisine, not yet sufficiently tasted and evaluated by their own chefs.

The components coming from the Fund tradition were incorporated directly in their raw form. Stabilization and external adjustment had to be pursued according to the old rules together with the structural reforms. Fiscal austerity, reduction in public expenditures and devaluation were all to help reduce domestic absorption and the current-account deficit. Mixed with the modernization flavors that promised to satisfy the appetite for growth of the LA countries, the recipe also included the bitter taste of external adjustment at any cost. In a context of high external debt, high rates of interest and international credit rationing, that component of the package implied giving priority to the generation of significant trade surpluses to facilitate heavy financial transfers.

The set of modernization and adjustment measures was a complex policy mix that came to life with lending conditionality while the economists of the Fund and the Bank attempted to rationalize it. The job seems to have been easier for the economists of the Fund than for their colleagues in the Bank, probably because it did not come along with any major change in the Fund's practice, whereas the Bank's staff was confronted with a very difficult task8. The comparative intellectual difficulties and the priorities determined by the practice of lending conditionality reflected in the substance of the earlier rationalizations, in which macroeconomic considerations and adjustment issues carried most of the weight, while structural reforms aimed at fostering growth emerged rather as complementary9.

Ideas evolved while experience accumulated. "Successful" cases played an important role in this process, providing empirical support and strengthening the rhetoric of policy proposals. For example, the Bolivian 1985 program was a model of a successful drastic reform and orthodox stabilization for some time. The Chilean growth recovery from the mid-eighties made the country the model of a successful trade reform. However, the selection of cases and policies was biased by predetermined ideas. On the one hand, the evaluations of the "successful" cases never went deep enough to provide a complete picture. In the Chilean case, for example, where the reforms were implemented in the seventies, little attention was paid to the dramatic crisis of the early eighties and no role was attributed to the fact that Chile, despite having the highest debt/GDP ratio in Latin America, was able to avoid realizing significant external transfers because it received much more support from the multilateral agencies. In the Bolivian case, no mention could be found of the fact that the external gap widened after 1985 and was financed by multilateral institutions because the country became eligible with the 1985 program. On the other hand, the selection excluded some obvious cases. For example, Colombia showed the best real Latin American performance in the eighties, but was rarely mentioned as a relevant experience because it did not provide a case for illustrating the promoted policy reforms.

An attempt at systematization was produced by John Williamson in 198910. The paper was properly entitled "What Washington means by Policy Reform" because the author aimed at putting together not only the explicit orientations of the Bank and the Fund but also the less formalized judgments of these agencies and those of the American administration. The paper did not seek a full rationalization of the promoted measures but it rather pursued the more modest target of providing a comprehensive presentation of the whole set. The very fact that this paper was written and the diffusion it had show that it came to fill a gap and that at the end of the eighties the policy package was still vague.

The modernization and adjustment set of policies was systematically presented and rationalized by the Bank in the World Development Report 1991 under the name of "the market friendly approach to development"11. While Williamson's paper could be read as friendly advice about what the agencies and the American administration saw as positive (what the author called "the Washington Consensus"), founded more on common sense and sensible practice than on theory, the WDR 1991 up-graded the set of policies and its rationalization to the status of a General Theory of Development. Beyond this ambitious aim and in spite of its inconsistencies (some of which may be attributed to the fact that it was written by many people) the WDR 1991 is the most complete presentation of the set of ideas that gained political momentum in the mid-eighties and evolved during the rest of the decade. The book should not be read as an academic product. As an official document of a multilateral institution, its contents had to reflect compromises and its edges be smoothed. For the same reasons, because it is a public statement, it does not include some delicate topics involving lending practices, for instance the cross conditionality of the Bank and the Fund and the requirement of a simultaneous agreement with the private creditors to be eligible for structural reform lending. More generally, most of the issues regarding the international financial context in which the policy reforms were to be implemented are disregarded in the document. Taking these facts into account, it is a bit surprising to see how audacious it is on some issues.

Nonetheless, and in spite of the fact that it was published at the beginning of the nineties, the Report belongs to the eighties. Its essence is an enthusiastic eulogy of a set of policies to allow countries to overcome economic stagnation and the persistent degradation of their standards of living, i.e. the situation that most countries were experiencing in the eighties. The "lost decade" is the implicit scenario of the document and it refers to what the countries should do in that context, although it carefully downplays the salient characteristics of the period: the debt crisis, its domestic consequences and the conditions that prevailed during the decade in the international financial markets.

II.2. Latin American policy urgencies and pragmatism.
In the ears of a Latin American country in the context of the eighties the message of the "Washington Consensus" or "market friendly approach" may have sounded as follows: "International factors may be important, but there is little you can do about them. Concentrate on taking the right domestic measures, because this is the only thing you can do and because it will make you eligible for multilateral support and attractive to international investors." Although the omission of international factors in the analysis and policy recommendations could have been considered cynical, the lack of power of Latin American countries to modify the international context that followed the debt crisis seemed to be a realistic assessment. So, any country adopting a pragmatic approach to the policy proposals might have asked itself three different questions:

First, are the "market friendly" reforms and policies the best way to achieve a development path, under normal conditions?

Second, will these measures, or any others for that matter, be effective if the economy continues to be obliged to effect heavy external transfers while facing international credit rationing? Although it was clear that the implementation of the promoted package was associated with multilateral financial support, it was also apparent that this support was insufficient to remove the external constraint and the pressures for additional external and fiscal adjustment. In some cases (e.g. privatization) there was a positive correlation between reforms and the financing of external and fiscal gaps. But there were also trade-offs, import-liberalization vs. the lack of external resources, financial liberalization and rising interest rates vs. the weight of domestic debt on fiscal expenditures, and devaluation vs. reduction of inflation.

Third, do the issues tackled by the MFA recommendations constitute the complete set of obstacles to stabilization and the recovery of growth, or are there other overlooked constraints (in addition to the external factors) that have to be addressed?

The previous argument tries to stress that from a pragmatic policy perspective the questions regarding the MFA proposals had to go well beyond the first, i.e. had to focus on other questions besides their general suitability as development tools under normal conditions. In conditions where most countries had experienced a decrease in per capita output and investment rates and the permanent threat of explosive financial and inflationary trends, the most urgent questions involved the policies needed to stop those trends. Let us emphasize that it was not merely a question of the distinction between stabilization and structural reforms, because in the extremely deteriorated context of the eighties these were inextricably linked, and any program capable of curbing the above-mentioned trends had to include substantial structural reforms. But these structural reforms had to be judged according to their contribution to the main policy task. Some measures, such as fiscal reform and privatization, fitted well in both the MFA and the effective policy requirements. Other promoted policies, such as domestic financial reform, were more or less neutral with respect to prevailing urgencies. Another set of measures, such as tariff reductions and financial opening, because of the mentioned trade-offs, had to wait for favorable international financial conditions.

The pragmatic approach helps to explain why MFA proposals were rarely discussed in Latin America from a developmental point of view. Besides, in many countries both policy concerns and the analysts' attention were focused on other issues. Potential participants in a debate on a development strategy were busy looking for ways out of the new constraints to growth established by the eighties context. Regarding the MFA agenda, calling attention to the missing issues was for many Latin American economists more important than discussing its development capabilities. In fact, there was not at the time, nor is there in the present, a more or less developed set of policies suitable for replacing the old development strategy without repeating its mistakes. This lack of alternatives is precisely the reason for this paper.

III. The new conditions in the nineties.
III.1. The global regional economic situation.12
The economic situation of the region has greatly changed in the present decade. Most Latin American countries have shown a positive growth rate and a fall in inflation. This has given rise to a new set of problems in the research agenda. Before discussing the new issues, it is important to look at the most important facts that determined the change in the Latin American economic environment.

What is it that changed in Latin America between the 1988-89 period, when the average growth rate fluctuated around zero and many countries were suffering from inflation rates approaching hyperinflation, and the 1991-93 period, characterized in most countries by positive growth and falling inflation. In answering this question, the role of the already implemented structural-reform programs is usually emphasized. However, the most remarkable difference between the two periods is the evolution of the external sector. First, there was a significant fall in the international interest rate. Second, there was a sudden and marked reversion in the direction of capital flows.

The decrease in the interest rate had a very important positive income effect on the region's national income and also induced a loosening in the external gap via the reduction in the financial services account deficit. While in the 1988-89 period the net payments of interest and profits abroad amounted to 36 billion dollars per year, in 1991-93 these payments totaled US$ 29.7 billion per year. This positive effect, nonetheless, was partially offset by the decrease in the terms of trade. So, despite the fact that the situation would have been worse if the interest rate had not been declining, it seems that the income effect of the diminishing interest rates was not strong enough to explain the improvement in the Latin American situation. But the fall in the international interest rate also generated an important substitution effect, explaining at least in part the observed reversal in the direction of capital flows. The reduction in the foreign interest rate made investment in financial assets issued within the region more profitable, helping to stop capital flight. The lower interest rate also raised the net return on investments in productive assets, which may be very important in explaining not only the volume of FDI flowing into several countries in the region, but also the success of privatization in countries like Argentina, where there was an active participation of multinational firms in the process.

The reversal of capital flows has been impressive. As a consequence of the fall in interest payments abroad and the increase in capital inflows, the net transfer abroad by the region became negative in 1991-93 for the first time in nine years. While Latin America transferred an annual average of 21.9 billion dollars abroad in the years 1986-90, in 1991-93 it received 22.3 billion dollars per year. The relaxation of the extreme credit rationing that the region faced during the eighties allowed many countries to finance a higher current account deficit. Consequently, there was a strong reduction in the trade surplus; indeed, for the first time since 1983, Latin America generated a trade deficit in 1992 and 1993.

With the relaxation of the external gap, many of the mechanisms that contributed to the seriousness of the crisis during the eighties were deactivated. First, the availability of external credit allowed an expansion of domestic absorption. In effect, the reversal of capital inflows was so abrupt and significant that many countries faced an excess supply of foreign exchange, even though the trade and current account deficits have been increasing fast. Consequently, the region as a whole accumulated international reserves during the period and most countries revalued their currencies.

Beyond its consequences on the balance of payments, the expansion of economic activity and the real appreciations had beneficial effects on macroeconomic stability. Fiscal revenues were buoyed by the recovery. The lower real exchange rate also contributed to fiscal balance by lowering the real value of interest payments on the outstanding public debt. Add the positive income and substitution effects of the fall in the international interest rate, it is not surprising to see that there was an extraordinary improvement in the fiscal equilibrium throughout Latin America in the last three years. Many countries in the region are now running fiscal surpluses. The lagging exchange rate also played an important role in the observed process of disinflation. In most of the countries this is one of the key factors explaining the significant fall in the inflation rate even in a context of expansion of domestic absorption.

Despite the improvement of performance in terms of inflation and recovery of activity level, the macroeconomic process in Latin America remains subject to important weaknesses. Two points deserve to be stressed. First, it is unlikely that the present situation of increased capital inflows and low interest rates that has induced a negative transfer abroad will persist in the future. Consequently, in order to sustain the present path of imports and domestic absorption, it will probably be necessary to increase exports at a higher rate in the future. But many countries are experiencing severe problems in raising their level of exports due to the lagging exchange rate. If the real exchange rate were corrected to eliminate the anti-export bias and reduce the trade deficit, there would be a worsening of macroeconomic stability both in inflation and fiscal balance. Thus, many countries are facing a trade-off between stability and competitiveness.

In the second place, it seems that the crisis of the eighties has left a strong negative legacy on the ability of most countries to restore a high growth rate path. The rates of investment and domestic savings, severely affected by the crisis, are still well below pre-crisis levels. In addition, the obsession with reducing the role of the public sector has cut public investment to extremely low levels.

III.2. A country focused analysis.
Although the description presented above seems to reflect the global regional situation reasonably well, there are significant differences across countries, even at the aggregate macroeconomic level. To get a more balanced view it is useful to classify the larger countries according to their growth prospects, with emphasis both on their main macroeconomic problems and on their relative fragility vis-รก-vis the international financial context.

A first group (Colombia and Chile) comprises those which have shown good growth rates for an extended period since the mid-eighties and do not suffer serious disequilibria which might threaten short-run stability. Their dependency on external finance to sustain growth is low. For different reasons and by different means, both economies have achieved acceptable balance in the fiscal and external accounts and not suffered extreme macroeconomic instability (by Latin American standards). In both cases, the closing of the fiscal and external took place prior to the new external financial conditions that the region has faced since 1991. Thus, growth recovery and macroeconomic stability were achieved independently of the new financial environment.

Argentina and Mexico are the prominent examples of a second group. These countries have been growing in recent years, but the growth process is more fragile. Stabilization programs based on the nominal exchange rate as an anchor of the price system are underway.. There is a persistent trend toward exchange-rate appreciation, although at declining rates, together with an increasing distortion of relative prices against tradeables. The real appreciation and the simultaneous opening of the economy are restraining exports and fueling imports, leading to a deterioration in both the trade and the current accounts. In this scenario, the magnitude of the external savings requirements is similar to that of the pre-crisis period in the early eighties. The sustainability of growth depends increasingly on external finance. The recent expansion has mainly been led by consumption. Although there was an increase in investment, the rate is still significantly below the pre-crisis level. In these countries, in brief, the projection into the future of present trends implies widening disequilibria. Consequently it is expected that there will be important changes in some macroeconomic parameters in order to make the growth process viable.

The defining characteristic of a third group (including Brazil and Venezuela) is the continued existence of the restrictions which typified the eighties. Brazil is experiencing very high inflation rates and GDP has been stagnant in the last years. After many attempts to close the fiscal gap (some of which succeeded in the very short run) there is the generalized belief that sustained fiscal equilibrium is impossible without a complete reform of the fiscal system. Many of the difficulties stem from the lack of credibility in stabilization shocks of any kind, following the failure of the many previous attempts. This is specially so regarding the entrepreneurial sector. Venezuela, on the other hand, has shown relatively high growth rates in the early nineties, but the cost was the reopening in 1992 of both the fiscal and the external gaps. The levels of external and fiscal disequilibria are comparable to those of the pre-1989 adjustment period. Although 1989 reforms were intended to transform the way in which the Venezuelan economy worked, trying to make it less dependent on oil and giving more room to the private sector, the outcome resembled the past more than had been expected. In 1990 and 1991 a favorable shock in oil prices and capital inflows stimulated economic activity and provided resources to sustain the closure of both the fiscal and the external gaps. Subsequently private consumption continued to increase, but then oil prices fell and capital inflows were not enough to compensate for the current account deficit, which had to be financed by public sector indebtedness and contraction of reserves. This process greatly resembled the dynamics of the eighties. The combination of a lagging exchange rate and falling oil proceeds produced a huge fiscal imbalance. The expectation that the leading role previously assumed of the state be taken after the reform by the private sector was not fulfilled. Private investment fell by 50% after the 1989 shock and has not recovered since then.

It should be stressed that both Brazil and Venezuela confronted serious political crises in the nineties. Political uncertainty eroded the credibility of economic policies and made it harder to reach political consensus for the fiscal reforms and stabilization policies that seem to be urgently needed in both countries. However, the similarities between Brazil and Venezuela that we have underlined should not conceal the fact that both Brazil's level of industrial development and its external situation will put it in a relatively better position if the political and fiscal problems can be overcome.

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