Chapter 15 Trade and Policy Reform in Latin America

Chapter Objectives Discuss the long-run performance of the economies of Latin America Examine the origins and extent of Latin America´s economic crisis of the 1980s Discuss the economic reforms of the late 1980s and 1990s Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

TABLE 15.1 Population and GDP for Latin America and the Caribbean, 2005 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

TABLE 15.2 Average Annual Growth in Real GDP, 1960–2000 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Import Substitution Industrialization Reliance on import substitution (ISI) policies from the 1930s to the debt crisis of the 1980s Raúl Prebisch of ECLA argued that Latin America experienced declining terms of trade (TOT): (index of export prices)/(index of import prices) 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 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Problems with Import Substitution Government involvement in production decisions caused a misallocation of resources Exchange rate overvaluation Policies were too biased in favor of urban areas Income inequalities worsened ISI fostered rent-seeking and corruption Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Macroeconomic Instability and Economic Populism Latin America has experienced macroeconomic crises over the past 50 years Crises are often attributed to populist policies: political movements using expansionary fiscal and monetary policies without regard of inflation risks, budget deficits, and foreign exchange constraints Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

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 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Stages of Populist Policies Economic stimulus through government expenditures and printing money Creation of bottlenecks Increase in prices and budget deficit Acceleration of inflation Pervasive shortages become pervasive Capital flight and decline in wages Resort to IMF help Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Debt Crisis of the 1980s Causes: Collapse of world oil prices (Mexico particularly affected) and increase in international interest rates in the early 1980s Longstanding political mismanagement High rates of lending in 1974–1982 Let’s analyze these in greater detail… Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

TABLE 15.4 Inflation Rates, 1982–1992 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Resolving the Debt Crisis 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 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Economic Policy Reform In the late 1980s, Latin America launched economic policy reforms The region adopted a neoliberal model—favoring free markets and minimal government intervention in the economy Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

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 scrapped Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

The “Washington Consesus” Macroeconomic reforms: 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 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

The “Washington Consesus” (cont.) Microeconomic reforms: 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 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

TABLE 15.5 Average Tariff Rates in Latin America Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Stabilization Policies to Control Inflation Some Latin American countries adopted the orthodox model—cutting government spending, reforming the tax system, limiting the creation of new money Others adopted the heterodox model—same as orthodoxy but also freezing of wages and prices Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Structural Reform and Open Trade In the 1980s, Latin American countries began reducing both tariff and nontariff barriers (NTBs) Regional integration schemes were revived: Central American Common Market (CACM), the Andean Pact, Caribbean Community (CARICOM) New regional integration schemes were created: NAFTA, Common Market of the South (MERCOSUR) Individual countries, especially Chile and Mexico, started negotiating bilateral free trade agreements Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

TABLE 15.6 Openness Indexes, 1985 and 2004 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Current Issues after the Reforms Neoliberalism is viewed negatively by many Latin American citizens because it has not resulted in stable economies, falling prices, or greater equality A second generation of reforms are underway to create more inclusionary economic systems A few Latin American countries, including Mexico and Chile, have become the most open and outward oriented of countries anywhere, but the results elsewhere have been disappointing. Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Chapter 15 Additional Chapter Art

TABLE 15.3 Debt Indicators at the Onset of the Debt Crisis, 1983 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

TABLE 15.7 Regional Trade Blocs Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Latin America Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Latin America: Trade Blocs Copyright © 2008 Pearson Addison-Wesley. All rights reserved.