1. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. Chapter 15 Trade and Policy Reform in Latin America

2. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-2 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

3. Introduction: Defining a Latin American Economy A Latin American economy is considered all of the Americas south of the United States (Websters dictionary) However, Latin America is quite diverse, and one needs to be careful not to over- generalize Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-3

4. Population, Income, and Economic Growth For long stretches of the 20 th 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 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-4

5. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-5 TABLE 15.1 Population and GDP for Latin America and the Caribbean, 2007

6. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-6 TABLE 15.1 (continued) Population and GDP for Latin America and the Caribbean, 2007

7. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-7 TABLE 15.1 (continued) Population and GDP for Latin America and the Caribbean, 2007

8. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-8 Import Substitution Industrialization: Origins and Goals of ISI Key points about reliance on import substitution industrialization (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 pessimismeach unit of exports would earn a declining unit of imports –ISI would boost industries that produce substitutes for imported goods

9. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-9 Criticisms of ISI 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 Income inequalities worsened ISI fostered rent-seeking and corruption

10. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-10 Macroeconomic Instability and Economic Populism Latin America has experienced macroeconomic crises over the past 50 years –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

11. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-11 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

12. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-12 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

13. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-13 The 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 Lets analyze these in greater detail…

14. Table 15.2 Debt Indicators at the Onset of the Debt Crisis, 1983 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-14

15. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-15 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

16. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-16 Economic Policy Reform and the Washington Consensus 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

17. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-17 TABLE 15.3 Inflation Rates, 1982–1992

18. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-18 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

19. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-19 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

20. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-20 TABLE 15.4 Average Tariff Rates, in Percents, Selected Countries

21. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-21 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 Individual countries, especially Chile and Mexico, started negotiating bilateral free trade agreements

22. 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 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-22

23. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-23 TABLE 15.5 Openness Indexes, 1985 and 2007

24. Table 15.6 Regional Trade Blocs Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-24

25. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-25 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

26. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-26 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

27. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-27 The Next Generation of 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

28. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-28