Changing the course of economic policy in Latin America

While the need to abandon the failed neo-liberal economic policies of the past two decades is self-evident, the problem facing Latin American leaders is how to reorient their economies to foster genuine development for the benefit of their people. Ariela Ruiz Caro considers the difficulties.

THE recent electoral results that ushered Luiz Inacio Lula da Silva and Colonel Lucio Gutierrez into presidential office in Brazil and Ecuador respectively are just some of the signs of a split in the Washington Consensus model that was implemented, to a greater or lesser extent, in Latin America during the 1990s.

The rejection of the model and demand for a change in policies, giving priority to social aspects and including mechanisms for the redistribution of resources generated, are manifest not only in the election results. One can also discern these in the expectations regarding forthcoming presidential elections in Argentina and Paraguay this year and, more distantly, in Uruguay in 2004. In Argentina, candidates from nearly the whole political spectrum, with the exception of former president Carlos Menem, endeavour to associate their image with that of the Brazilian president, while in Uruguay the political forces gathered in the Frente Ampio (Wide Front) are consolidating participation on the national scene. 

Rejection of the economic model is also expressed in social conflicts such as those that took place in Peru and Paraguay last July, which prevented the privatisation of some state companies in the electricity sector that had been decided on by the respective governments.

More recently, in Bolivia, the social outburst in the middle of February deeply shook the foundations of the economic model in force in that country since 1985, leaving President Gonzalo Sanchez de Lozada’s authority and credibility much reduced and his legitimacy questioned.  The country is going through a serious crisis of governance, which is threatening the continuity of the Sanchez de Lozada administration.  The opposition is demanding his resignation six months after having taken up office. 

The social outburst in Bolivia caused the loss of over 30 lives as a result of the people’s protest against the introduction of a 12.5% tax on Bolivians’ salaries to address the budget deficit, which in 2002 stood at 8.5% of the GDP.  The causes of the deficit are, firstly, the high level of foreign debt service, reaching 70% of the GDP, and the high cost of pension reform, due to the establishment of private pension funds.1 

Opposition to the introduction of such a tax was headed by police regiments rebelling against the government.  Faced with the possibility of this protest becoming widespread, the government ordered the army to stifle it, thereby provoking the reaction of other social sectors dissatisfied with the economic policy.  In fact, not only the university community and the Bolivian Workers Union (Central Obrera Boliviana - COB), but also the business community rejected this measure, which was finally revoked, with the ministerial cabinet resigning en masse.  However, the crisis continues and the government has even said that the country is ‘broke’. All the sectors are demanding a reorientation of the economic policy and the abandonment of the neoliberal model that, after 17 years of implementation, has not shown the expected results. 

For many politicians and worker sectors, pacification of the country will be achieved if the President resigns and a structural change is introduced, implying - according to the Movement towards Socialism (Movimiento Al Socialismo - MAS), the second largest political force in the country headed by the coca plantation leader, Evo Morales - the recovery of the gas company for the Bolivians and revision of the contracts of privatised companies, among other things. 

Difficulties in changing the course of economic policy

One of the central aspects to be taken into consideration by Latin American leaders, both regarding policy decisions and regarding structural reform processes, is the impact they have on the welfare of the poorest sectors and on the distribution of income as a whole.  In this respect, the redistributive action of the State is essential to guarantee equal opportunities, maintenance of democracy, economic growth and respect for the contracts and credits it has taken on, both domestic and foreign. 

However, changes in the domestic economic policy in countries led by presidents critical of the neoliberal model, are not yet visible.  In Ecuador, Colonel Gutierrez, elected only two months ago, has not been able to avoid increases in prices and in the rates of public goods and more taxes, although these have been accompanied by some social measures attempting to compensate their effects. 

According to some Ecuadorian analysts, the speed with which the present government approved a Letter of Intent with the International Monetary Fund (IMF) (the 10th such document to be signed in the past 20 years) ‘does not reflect any significant changes in the government’s negotiations with this entity, and is far from coinciding with the proposals made by the winning candidate in his campaign. He had offered to seek a new course for the economy, saving the country from painful adjustments.’2

The inflationary content of the new adjustment may affect those sectors that have already lost their competitiveness and are suffering the consequences of increasing foreign competition, while it may also reduce even further the purchasing power of the population.  There is no doubt that this will have an especially damaging effect on an economy that was dollarised three years ago and that has undergone continuous adjustments since then. 

For some, the greatest concern resides in the fact that many political parties, protagonists of resistance to IMF adjustments, which appeared as potential bearers of alternative proposals seem to have left to one side their innovative proposals presented during the electoral campaign, excluding the possibility of constructing an alternative and applying a model that, far from being innovative in its central aspects, is ‘a repetition of a well-known libretto’.3

On the other hand, in Brazil, the situation is extremely complex. During his speech at the reopening of the regular sessions of the Brazilian Congress in mid-February, President Lula warned that ‘the adjustment will last as long as necessary.’ The measures taken during his first 45 days in office gave rise to feelings of mistrust among his traditional bases.  Drawing a picture of a turbulent scenario, the Brazilian President stated that ‘the stability of our currency is under threat’, that people are ‘witnessing with concern the drop in their salaries’, that inflation ‘has become a real threat’ and that ‘the foreign exchange rate continues to be unstable.’4 

President Lula maintains that a transformation of the economic model cannot come about overnight and that it will take time, mainly because ‘we do not want to return to inflation and because we firmly intend to maintain financial balance - as has always been the case with the state and municipal governments of the Workers Party - to respect contracts and ensure that domestic conditions are attractive to national and international productive investments.’  The President considers that ‘there will have to be a transitional period in which we will have to tolerate the limitations imposed on the economy by past policies.’

However, the inflationary process has started to damage the popularity of the Brazilian President.  During the first month of the year, the extended consumer price index (ECPI) was 2.25%. At this rate, the index may reach 27% by the end of the year, that is to say, three times the goal agreed on with the IMF for the year - 8.5%. This could deteriorate the expectations of a salary increment for Brazilian workers, who for years have been losing purchasing power while facing inflation. 

During the third week of February, the Central Bank increased the interest rate for the second time since the government took up office, from 25.5% to 26.5%.  The adoption of this measure has generated criticism from within the ruling party itself. The radical sectors within the Workers Party are warning that during the election campaign the party had promised to lower the interest rate to generate more employment.5 

Opposition sectors point out that ‘the orthodox method of raising the interest rate to contain inflation’ is being applied by the government of a Workers Party which for eight consecutive years attacked Fernando Henrique Cardoso’s government policy of high interest rates.  However, it is considered to be the only way of halting inflation and avoiding a spiral into hyperinflation. So long as the economy does not recover, the patience of the productive sector is starting to wear thin and many consider that ‘the measures taken will curb the country’s development.’6 

Visible results in foreign policy

In spite of the difficulty in adopting measures which reverse the economic model, in Brazilian foreign policy, greater emphasis is placed on the government’s position of national re-establishment and integration.  In fact, the Brazilian President considers that, if economic, social and political changes are to be launched, modifications have to be made regarding Brazil’s position in relation to the rest of the world.

In this context, the submission by the Brazilian government of proposals for establishing links is a concrete sign of the course taken by the administration in the international arena.  Its priorities are the links with South American countries, by way of strengthening not only economic relations but also and above all, political ones. 

However, this does not mean that this was not a priority too for Lula’s predecessor, Cardoso.  Brazil is one of the few countries in the region to have long-term State policies regarding its relationships with foreign countries. Its development strategy is aimed at a diversified specialisation pattern, and the country does not want trade negotiations to result in changes in its profile, implying regression to specialisation in primary commodity production. Cardoso was an acute critic of the proposed Free Trade Area of the Americas (FTAA) and one of the promoters of a South American Free Trade Association (SAFTA) as a first step to establishing a free trade zone with the United States. 

President Lula has taken some important foreign policy initiatives. In January, he promoted the establishment of the ‘Friends of Venezuela’, with the aim of contributing to the preservation of that country’s democratic stability during the two-month-long opposition strike which demanded President Chavez’ resignation.

In the framework of MERCOSUR - a subregional integration body comprising Argentina, Brazil, Paraguay and Uruguay which aims at establishing a common market - relationships have been enhanced with the member countries, making it possible to establish a common agenda including issues that were almost prohibited in the operation of MERCOSUR.  For President Lula, this subregional integration body must become a forum for industrial, agricultural, social, scientific and technical convergence, in which cultural rapprochements are also promoted.  One of the most important aspects of the present situation is that emphasis is placed on achieving macroeconomic coordination among the four countries’ central banks, aimed at establishing a common currency.7

Furthermore, the Brazilian government has played a leading role in the negotiations to set up the FTAA, which is slated to enter into force at the beginning of 2005.  MERCOSUR, at the initiative of Brazil, has submitted jointly two proposals to preserve its autonomy regarding industrial policy and foreign trade, causing unease among the United States and Canadian governments. 

The first proposal consists of a ‘nascent industry clause’, which attempts to preserve the option - even after the FTAA has been established - of granting tariff protection to infant industries. This measure is aimed at attracting foreign companies to MERCOSUR, by protecting the initiation of local production.  The second proposal foresees the possibility of establishing safeguards (balance-of-payments clause) to limit excessive imports.  Such safeguards may only be applied in times of crisis, with the aim of protecting the country’s foreign exchange reserves. 

In another foreign policy context, the Brazilian government has aligned itself with the positions of France, Russia and Germany against the military solution promoted by the United States for the disarmament of Iraq. At MERCOSUR level, the government promoted a declaration by the member countries in which they agreed that only the UN Security Council is able to decide on the use of force against Iraq.  In fact, the foreign ministers of Argentina, Brazil, Paraguay and Uruguay reiterated that ‘the Security Council, as the body responsible for maintaining peace and international security, is the only body having the legitimacy to authorise the use of force.’  The inspectors ‘must have sufficient time to carry out their tasks with the full and comprehensive cooperation of the Iraqi government’, states the text, which adds that ‘the Ministers of Foreign Affairs reiterate their repudiation of terrorism and of weapons of mass destruction’ and ‘support peaceful efforts to fully enforce Resolution 1441’.  Furthermore, according to some press reports, the Brazilian ministry of foreign affairs is trying to call a meeting of South American foreign ministers in order to forge a common front against the war. So far, though, this has not taken place. 

It is therefore probable that Brazil will strengthen and lead this type of position at international level, convening other countries that on their own would lack the strength to speak out or establish autonomous foreign policy positions. In this respect, it would be possible for Brazil and Argentina to turn foreign debt into an instrument for political integration, one which could bring together other countries of the region shouldering an excessive debt burden. 

Orchestration around foreign debt

In his recent publication Is Brazil Next?, John Williamson, who coined the term ‘Washington Consensus’, maintains that Brazil’s high rate of indebtedness makes its crisis similar to Argentina’s.  According to the economist, the greatest challenge facing Brazil is reducing its foreign debt, most of which is indexed to the dollar and which represents 75% of the total indebtedness of the public sector.  This task could lead to a weakening of Brazilian banks, the owners of 30% of official bonds. According to Williamson, this would necessitate assistance to financial institutions once again, as was the case in 1995, unless the government decides that the cost be borne by the depositors. 

In spite of the differences between both economies, it is worth recalling - with respect to the $30 billion loan approved by the IMF last October for Brazil - the results of the famous financial assistance package granted to Argentina.  This $40 billion loan, which had the participation of the IMF, the World Bank, the Inter-American Development Bank (IDB), the government of Spain and some private banks, established an insurance fund against default, to which the government could have recourse in the event that it could not meet its debt service obligations. It was hoped that this guarantee would lessen the country risk and the cost of new loans, thus contributing to economic recovery. However, the loan masked the fact that the debt, in the way it was structured, was impossible to pay. 

In fact, months later, payments on maturing bonds had to be postponed (mega-exchange) and part of the debt restructured at lower rates of interest. However, the variables of indebtedness had acquired dynamics of such a nature that they overcame any measure taken.  It was too late: Argentina, like many other countries, had only been sweeping the debt problem under the carpet, with the backing of multilateral funding bodies, developed-country governments and international capital, which now do not reject the idea of Brazil being the next large country to fall. 

It is important to remember that when in 1989 the then US Treasury Secretary Nicholas Brady accepted the shrunken market values of the Latin American foreign debt deeds as a basis for his restructuring programme, the governments of the region hopefully expected an end to the crisis. The so-called Brady Plan enabled them to lessen the enormous foreign debt taken on by private banks and was complemented by an economic policy (the Washington Consensus) geared towards regularising debt service payments and, therefore, the countries’ reinsertion into the international financial system.  Fiscal discipline, resources from the sale of public companies and an overvalued exchange rate - which made it easier to collect the dollars needed to service the debt - calmed both debtors and creditors. 

However, the foreign debt problem was not resolved.  The mechanisms of its devastating and cyclical rationale remained intact, based on the fact that the available economic surplus in the region was not reinvested but transferred to industrialised countries.  Between 1990 and 2001, foreign debt in the region grew from a level of $450 billion to $740 billion. 

With capital flows to the region having shrunk for over four years now, the countries are taking on new debts, which will not be channelled towards the real economy but will cover the maturity of previous debts.  This has given rise to an economic contraction and increasing pressure on national budgets as a result of the debt servicing. To varying degrees, this is what is happening presently in Latin American economies. 

Conditions for foreign funding have deteriorated considerably due to the higher levels of country risk, which in turn are determined by the recessionary scenario.  The average cost of borrowing for the region is over 15%, greater than that recorded when the Russian debt moratorium took place in August 1998. With such costs, credit has practically become inaccessible. Coupled with the continuous drop in direct investment flows, this means that for the fourth consecutive year, the region will suffer a net transfer of resources abroad. In other words, capital inflows will not be sufficient to compensate for profit repatriation and interest payments. 

The recession which has been afflicting the region for the past four years, added to the high volume of debt, exerts strong pressure for the adoption of fiscal measures contemplating reductions in expenditure or increases in taxes. A situation as adverse as the present one has not been recorded since the first half of the 1980s in the midst of the foreign debt crisis. 

Given the regional scope of the instability in Latin America, solutions should be sought in this context through the establishment of some orchestrated action, for example for the treatment of foreign debt service. The United States government and the IMF have temporarily avoided default in Brazil and have patched up the situation in Uruguay and Paraguay. However, the problem is latent, and once again, an avenue has opened up for concerted Latin American action.                                                             

Ariela Ruiz Caro, a Peruvian economist, is a consultant for the UN Economic Commission for Latin America and the Caribbean (ECLAC). She was formerly an official with the Andean Community of Nations and has participated in the Latin American and Caribbean Information Exchange Programme on External Debt at the Latin American Economic System (SELA). The views reflected in the above article are the sole responsibility of the author.


1    El Diario, La Paz, 13/02/03.

2    Newspaper La Repœblica, 15/02/03.

3    Ibid.

4    Newspaper  Folha  de  Sao  Paulo, 18/02/03.

5    The president of the Fuerza Sindical union, Paulo Pereira da Silva, has condemned this decision, pointing out that increasing interest rates means that the government is showing signs of effecting an imbalance between the people’s aspirations regarding employment and economic growth and speculators’ interest. 

6    Communication by the President of the Brazilian Association for the Electro-Electronic Industry, Carlos de Paiva.

7 Newspaper El Mercurio, 15/02/03, Santiago, Chile.