SIX months ago, such was the gloom about Latin America that investors and international finance officials were asking whether it would be Brazil, the region's giant, or one of three or four of its neighbours, that would be next in line to follow Argentina into debt default. Now, that pessimism looks wildly overdone. Brazil has stepped back from the brink: its currency and its bonds have rallied strongly, after its new centre-left government committed itself to tight fiscal and monetary policies. With risks and sluggishness elsewhere in the world economy, money has trickled back into Latin America. Taken as a whole, the region should grow by at least 2% this year and 3.5% next year, according to the World Bank. Even Argentina, after a four-year slump, is growing again. So panic over—but not the debate about what has gone wrong.
Officials at the IMF and the World Bank caution that while the short-term outlook has brightened, Latin America faces deep-rooted obstacles before it can achieve high and sustained growth. And a still-anaemic recovery cannot assuage the deep sense of dissatisfaction left behind by Latin America's recent travails (see chart 1). Last year, the region's GDP shrank by 0.6%, after growth of just 0.4% in 2001. Income per person in Latin America now stands 2% below its level of 1997, according to the UN Economic Commission for Latin America (ECLAC). Progress in reducing poverty has halted (see chart 2). This amounts to a “lost half-decade”, says ECLAC, harking back to the “lost decade” unleashed by Mexico's 1982 debt default.
This slump has been all the more painful because of high hopes that Latin America was finally on course to catch up with the rich world. The region grew fast in the 1960s and 1970s, when many countries industrialised; but most Asian countries grew faster still. In Latin America, the growth was marred by exaggerated protectionism and bloated, but inefficient, states, culminating in the debt crisis. But a dozen or so years ago, most Latin American countries, many of them newly democratising, changed course: they implemented a set of free-market policy reforms. These came to be known as the “Washington consensus” (a term coined in 1990 by John Williamson, of the Institute for International Economics, a think-tank in that city). At first, the results were promising: inflation, a chronic Latin vice, was slayed; growth surged again, and poverty began to fall.
Subsequent recessions and financial crises, especially severe in South America, have wiped away some (in places much) of those gains. They have also prompted much heart-searching as to what has gone wrong. Many Latin Americans conclude that the answer is the “neo-liberal” reforms themselves. These are held not just to have failed to deliver sustained growth, but to have made the region more vulnerable, and to have increased unemployment, poverty and inequality. Privatisation in particular has become deeply unpopular: privatisations of a water firm in Bolivia in 2000, and of an electricity generator in Peru last year, were scrapped after riots. As a result of all this, some political pundits assert that Latin America is sinking back into populism and/or anti-market leftist nationalism. And they wonder whether the reform process will survive political change.
Moisés Naím, the editor of Foreign Policy magazine and a former Venezuelan trade minister, was surely right when he declared last year that the “Washington consensus” is a “damaged brand”. But are the critics right that the reforms failed, and if so, why? Is the “Washington consensus”, in fact as well as rhetoric, being abandoned by the region's governments? If so, what might (or ought to) take its place?
Some of these questions have been addressed in a new book by a group of (mainly Latin American) economic reformers, co-edited by Mr Williamson and Pedro-Pablo Kuczynski, a former Peruvian economy minister*. But before considering their proposed revisions to the reform agenda, another question must be asked. What did the original “Washington consensus” really mean? Not what is often claimed by its critics, for whom it quickly became a synonym for the “neo-liberal” (more accurately, neo-conservative) agenda of the governments of Ronald Reagan and Margaret Thatcher. Mr Williamson points out that his original article was “a reporting job” rather than a manifesto, in which he tried to sum up (for a conference held in Washington, DC) in a 10-point list a reform agenda that was emerging among Latin American policymakers (the article can be found at www.iie.com/jwilliamson.htm). His list did not include monetarism, supply-side economics, or a minimal state. What it did comprise, in summary, was fiscal and monetary discipline, opening up to foreign trade and investment, and large-scale privatisation and deregulation.
To the critics, the prime exhibit in the case against the “Washington consensus” is Argentina's dreadful slump. Yet that, too, is a misreading. What brought Argentina down was the combination of its fixed exchange rate, which made its currency uncompetitive, with persistent fiscal deficits. Not only were these mistaken policies; they were in explicit contradiction with Mr Williamson's list.
Elsewhere, the reforms did bring lasting benefits. In Chile, an early reformer, fast growth saw poverty halved, to 23%, between 1987 and 1996. Overall, macroeconomic management in the region improved dramatically compared with, say, the 1970s. There was social progress, too (see table 4). Partly because governments pulled back from running steelworks and factories, they spent more on education and health. In some countries, such as Brazil and Mexico, new, targeted, anti-poverty programmes were introduced. Where income inequality worsened, it was mainly because of recession, not reform.
Privatisation was not the blanket failure painted by the critics. There is little argument over the sale of state industries. Public utilities are more controversial. In some countries, their sale was badly handled: either tainted by corruption, or by private monopolies, or because regulation has been poor. But private provision of telephones, electricity and water has vastly increased their coverage and quality. However, that has generally come at a price: as subsidies were withdrawn, tariffs often rose, before later starting to fall.
None of this is to deny that, overall, the return from reform has been disappointing. There were several reasons for that. Most relate to long-standing Latin American weaknesses. First, there was the region's chronic vulnerability to balance-of-payments crises. Second, the basic macroeconomic reforms were not fully implemented. In particular, most governments failed to save in good times, and piled up debts. Third, it was quickly accepted that if macroeconomic reforms were to produce higher investment and thus more jobs, they needed to be complemented by “second-generation” or institutional reforms. These range from improving education to bankruptcy proceedings. They are easy to list but hard to do. And fourth, some reformers, as well as critics, argued that in a region of deep income inequality, growth alone would not swiftly reduce poverty.
The single most important failing was the region's dependence on volatile capital flows. Growth before 1997 coincided with record capital inflows, some attracted by privatisation. As a result, currencies became overvalued, hurting exports and local producers, and leading to big current account-deficits. A first hiccup came in 1994-95, with Mexico's devaluation. Then, in mid-1998, emerging-market investors suffered big losses when Russia defaulted. For South America, that triggered what Guillermo Calvo, the chief economist at the Inter-American Development Bank, has called a “sudden stop” in capital flows (see chart 5). To compensate, governments had to adjust the real exchange rate (ie, either devaluing the currency or making output cheaper through price deflation).
Since most countries had beaten inflation by pegging their exchange rates, that was difficult (especially so for Argentina, which had fixed its peso by law). In many countries, most savings and debts were in dollars. So devaluation risked financial chaos. To make matters worse, governments' debts became more expensive to service. So they had to cut other spending, exacerbating recession.
Lessons from the adjustment
Now, most Latin countries have competitive exchange rates. “The adjustment has happened. It was very powerful, but it's over,” says Mr Calvo. The challenge, he adds, is to develop institutions and mechanisms to allow the orderly transfer of capital from north to south. One answer would be a central bank for emerging markets, to ease adjustment by providing liquidity. But there is no political will for that.
So attention is focusing on other “crisis-proofing” measures. Exports are vital. Mexico and Chile were the only two of the region's larger countries to register double-digit annual increases in the volume of their exports throughout the 1990s. Not coincidentally, they escaped the worst of the turmoil of 1998-2002. So further trade opening would help. But the United States is offering less generous terms in the talks on a 34-country Free-Trade Area of the Americas than it did to Mexico in NAFTA.
For export growth, maintaining a competitive currency is important. So most countries are likely to stick to floating exchange rates. Adopting the dollar may make sense for small and open countries in Central America and the Caribbean. For Argentina, it would be “insanity”, says Mr Williamson. He argues that preventing overvaluation may also require a return to selective controls on capital inflows (not outflows, as in the 1970s). These worked well for Chile. In the 1990s, the IMF pushed strongly for Latin American countries to lift all capital controls. Many academics now believe this should have been done more gradually.
Another priority is to stimulate saving and borrowing in local currencies. The main hope here is pension reforms, which have created growing investment funds in Latin American countries. Again, Chile and Mexico are leaders. Chilean firms can borrow long-term in pesos; Mexican companies switched some $4 billion in foreign debt to local currency last year.
The second aspect of “crisis-proofing” concerns fiscal policy. Governments have begun to write fiscal discipline into law. But many are poor at restraining spending in good times. A more effective fiscal policy would involve surpluses when growth is high, and borrowing only to finance public investment. It also requires reforms of tax and provincial finance. In many countries, local governments depend not on local taxes but on transfers from the centre, which rise along with government revenues. But as Enrique Iglesias, the president of the Inter-American Development Bank, notes, there is much resistance to counter-cyclical fiscal policies, stemming from a political perception that they help the next government.
Apart from crisis-proofing, Mr Kuzcyinski and Mr Williamson make recommendations on three other sets of issues. The first is completing “first generation” reforms. They note that least progress has been made in the labour market. Across the region, unemployment and “informal” jobs both grew during the 1990s. They propose reforms to severance pay and ancillary benefits, to reduce payroll taxes.
The second item is institutional reform. Many development economists now argue that institutions are crucial for growth. Here, the reform agenda is a diffuse one, including: a career civil service; better banking supervision; bankruptcy laws that allow banks to collect loan guarantees; and what Mr Williamson calls “industrial policy's modern relative”, a national innovation system for new technology.
Thirdly, the “new Washington consensus” includes some policies designed to reduce inequality. Recent research suggests that inequality in developing countries itself tends to reduce growth: savings and investment become the preserve of a small rich elite. While warning of the potential cost to economic efficiency of actions to improve income distribution, Mr Williamson concludes that “in a highly unequal region such as Latin America, opportunities for making large distributive gains for modest efficiency costs deserve to be seized.” To that end, he suggests more effort to collect income tax, and higher property taxes. But more emphasis goes to helping the poor gain assets, such as education and property titles, and through land reform and microcredit programmes.
Which way forward?
The way forward, Mr Williamson concludes, is to “complete, correct, and complement the reforms of a decade ago”, not to reverse them. But can this new formulation command a consensus? However cautious, references to selective capital controls, the role of the state, and income distribution all point to the reform agenda moving towards the centre. Some free-marketeers will object.
On the other hand, the region's new centre-left governments, such as that of President Luiz Inácio Lula da Silva in Brazil, might agree with much of this new agenda. One interpretation of the past six months in the region is that the left has signed up to the “Washington consensus”, at least in practice. Lula's government has not only tightened monetary and fiscal policy, it is pursuing the structural reforms espoused by its predecessor. This is not simply tactical, insists a member of Mr da Silva's inner circle of advisers. The government's targets include doubling the efficiency of existing social spending in four years, and raising exports by 10% a year.
But there is still plenty of room for disagreements. Perhaps the biggest is on the role of the state. “We don't want to renationalise anything, nor strengthen the state in a traditional sense, but we do want a state that plans things that are fundamental for a development project,” says José Genoino, the president of Lula's Workers' Party.
That position is echoed by José Antonio Ocampo, ECLAC's boss. “The ‘Washington consensus' wanted to think that growth would be automatic, but it needs active public policies,” he says. He argues that while open trade has made some firms very competitive, these have become enclaves, with few links to the rest of the economy. He wants governments to adopt “technology policies”, “strategic visions” for different economic sectors, and to help small and medium firms. He notes that Chile, the reformers' darling, employed such policies. He adds that two ways of doing all this would be through government procurement and state-owned banks—both anathema to the reformers. Two other areas of controversy are labour reforms and further trade opening.
Few argue for turning the clock back to the 1970s. But there is a risk of re-regulation by a thousand obscure decrees and of incremental government hand-outs in the name of industrial policy, aggravating the low productivity and lack of competitiveness that dog the region. On the other hand, by grounding its recommendations more clearly in the region's economic history and institutional realities, the “new Washington consensus” has moved closer to becoming a Latin American product. How much of a consensus it will command, and whether it will guide the region back to growth, remain to be seen.