Forum on Economic Reform (Part VII)
In recent decades the alliance of neoclassical economics and neoliberalism has hijacked the term “economic reform”. By presenting political choices as market necessities, they have subverted public debate about what economic policy changes are possible and are or are not desirable. This venue promotes discussion of economic reform that is not limited to the one ideological point of view.
The Future of Economic Policy Making
by Left-of-Center Governments in Latin America:
Old Wine in New Bottles?1
Juan Carlos Moreno-Bri2 and Igor Paunovic3 (United Nations, Mexico)
To assess the medium-term economic prospects of Latin America, a fundamental element to be considered is the recent emergence of left-of-center governments in the region. What economic policies do they implement? How do these differ from the orthodox ones put in place by their predecessors? Will, as their advocates argue, governments of this “New Left”4 adopt strategies – radically departing from so-called neo-liberal ones – that will help Latin America to enter a path of high and sustained economic growth? Or, on the contrary, are their fierce critics correct in stating that such alternative programs are revamped versions of populist experiments and, thus, sooner or later, will provoke acute inflation, bloated fiscal deficits, and push the region into financial crisis and recession? Other elements to take into account are the constraints imposed by the world economy and the international financial markets. In this paper we put forward a succinct assessment of these elements in order to examine the economic policymaking of the New-left governments in Latin America, and their results so far..
A key root behind the region’s shift to the left is the disappointing result of the economic reforms – inspired by the Washington Consensus – implemented by previous governments.5 Indeed, after nearly two decades of drastic macroeconomic reforms favoring trade and financial liberalization, deregulation, and downsizing of the public sector, Latin America is still unable to enter a path of high and sustained economic expansion. Inflation has come down, but economic activity has been sluggish. In addition, in the last ten years, the region has suffered acute economic crises; among the most conspicuous ones were the Mexican tequila crisis and the financial collapse in Argentina a few years ago.
During the 1980s the average real per capita GDP declined in Latin America due to the debt crisis. In the 1990s it expanded at 1.5 percent per year; four points below the average of developing countries in Asia. Moreover, between 1980 and 2000 the income gap between Latin America and the OECD widened, and there was scant progress in the reduction of poverty. By the beginning of the Millennium, close to 50 percent of its population lived in poverty, with 25 percent in conditions of extreme poverty. And, particularly worrisome, Latin America remained the most unequal region in the world.
Not surprisingly, Latin Americans became critical of the neo-liberal economic policies implemented. Latinobarómetro showed that by 2000 less than 30 percent of the population across the region believed that privatizations were beneficial, an approval rate 30 points lower than a few years before. The majority considered saw the market economy as the main road to development, but less than 25 percent claimed to be satisfied with its results. By then more than 50% were against the view that the state should not intervene in economic affairs. And physical insecurity and the lack of employment were regarded as the major concerns of Latin America.
On the other hand, the success of China – and other Asian economies – in luring vast inflows of foreign direct investment and maintaining a rapid economic expansion based on heterodox polices that allowed for an active role of the State in the economy, contributed to further undermine the credibility of the Washington Consensus. Thus, at the same time that the native population was becoming weary of the conventional economic strategies, the left-wing parties’ campaigns in favor of a new development agenda were attracting respectability. An additional element in their favor was the fact that, after 9/11, Latin America appeared to drift away from the United States’ screen of geopolitical priorities.
Rhetoric and Reality
The above mentioned factors shifted political preferences in Latin America, allowing for a number of left-wing parties to be ushered into power through democratic elections. The debate about the macroeconomic policies adopted by these New Left governments is ideologically charged, with rhetoric tending to prevail over reality. Their supporters defend them as alternatives to counteract the adverse effects of the neo-liberal agenda, while their critics brand them as populist programs doomed to end in a financial and economic crisis..
A preliminary inspection of the recent economic performance of the region suggests that the macroeconomic policies put forward by the New Left governments to date are not the irresponsible populist public spending experiments that their critics describe.
Figure 1 indicates that during 2003-05, the performance of medium and large Latin American economies under left-of-center governments (with the exception of Venezuela) does not substantially differ from that of other medium and large economies in the region under governments with a right-of-center political orientation. During this period the former governments have, on average, been somewhat more successful in sustaining a high rate of economic expansion, but less so in achieving low rates of inflation. Differences between both groups shrink if Venezuela is excluded. Note that in these three years the group of left-wing governments held tighter fiscal positions than other economies here considered. Indeed, whether Venezuela is included or not, the former group registered an average fiscal deficit lower than one percent of GDP, compared with an average of more than three percent for the other group. With the caveat that it is probably too early to draw firm conclusions, it seems that the New Left governments do observe fiscal prudence.
The case of Venezuela deserves a special comment to the extent that its fiscal position relies on oil revenues (50%), though the same can be said of Mexico, where the oil sector contributes 40 percent of total public revenue. The fiscal situations of both countries are vulnerable and, unless additional sources of tax revenues are exploited, may become even more problematic if world oil prices decline significantly. In this event in particular, subsidies for food and health care for the poor in Venezuela may be subject to severe cuts.
To partially compensate for the adverse impact of high oil prices on consumers, many countries grant subsidies or set price controls on gasoline. In Argentina, to cut down inflation, the government has not updated utility rates, and has set up agreements to impose price caps on a range of basic goods, including beef, with wholesale stores and producers,. These measures will be ineffective if the Argentine economy continues growing, as it has, at real annual rates of 9 percent or above, unless additional investment comes forward to ease supply-side bottlenecks. In this regard it is important to point out that the government has put in place special incentives to stimulate the investment in sectors that produce key inputs or other goods intensive in innovation. In addition it recently banned the export of beef, in order to insure the supply for the domestic market.
A characteristic of the New Left’s economic strategy is its marked effort to strengthen the margin of autonomy of macroeconomic policy by the reduction of public foreign debt. Argentina – against the advice of the IMF – negotiated with its foreign creditors and managed to restructure its external debt in the largest operation of its kind in history, obtaining a discount of 70 percent on close to US $100 billion. In addition, some New Left governments in mineral-rich countries have significantly increased their fiscal revenues by renegotiating with transnational companies the distribution of rents from the exploitation of natural resources. This has been done by increasing royalties and tax rates or, in Bolivia’s radical move, by moving for the nationalization of such resources.
For fiscal policy to have the capacity to act in a counter-cyclical way, Latin America (on both sides of the political spectrum) needs comprehensive fiscal reforms to: 1) increase tax revenues as a proportion of GDP by at least 5 points above their current range of 10-20 percent, and 2) implement a more progressive tax system that will affect income distribution. Some advances have been made, but fiscal reform has a long way to go. It remains to be seen whether recently adopted measures to tax exports of certain commodities and financial transactions will be only temporary fixes, and soon abandoned to avoid their long-term distorting effect on production.
Fiscal prudence has been accompanied in most new-left governments – with perhaps the exception of Brazil - by a commitment to avoid a persistent and significant appreciation of the real exchange rate. Indeed, through open market operations, Central Banks have been reducing the supply of foreign exchange in the domestic arena and, simultaneously, increasing their external reserves. This orientation of monetary policy implies a recognition that the exchange rate has an important influence, not only on domestic inflation but also on international competitiveness.
Another essential element in considering the adequacy of the New Left’s macroeconomic policies is the extent to which the government interferes in wage settlements. Argentina enacted income policy measures to strengthen the purchasing power of poor and middle income families. Uruguay, in addition, reinstated the old institutions of Wage Councils (Consejos de Salarios), which are once again the institutions where wages are negotiated at a national level. Most of the new governments in the region have decreed a significant but far from excessive hike in minimum wages, given the deterioration they had had in real terms in the past. Such restraint may reflect the fact that policy makers are concerned more with creating jobs than with improving employees’ earnings in formal labor markets. It also reflects the recognition that, unless backed by increases in productivity, nominal raises in minimum wages may fuel inflation with scant effect on real wages. In any case by 2005, with the exception of Chile, the real average earnings of workers in countries under left-of-center governments were still below their level in 2000.
So far, radical measures to alter income and wealth distribution have not been included in the New Left agenda.6 They have been ruled out due to political and electoral, as well as to economic considerations. In particular such measures, when unless they have a wide and strong political supports, tend to weaken the business climate and alienate part of the electorate. In addition, recall that New Left governments took power accompanied not by the noise of bullets but by ballots in free elections. Consequently, these governments are very much aware of the impact of their policies on the overall electorate. And some of these governments are backed by coalitions of diverse political trends and sectors, coalitions that may be not be solid enough to support radical redistribution policies or fiscal reforms.
International relations are one area where the economic policies of the New Left governments depart from previous models, as virtually all left-leaning countries are moving toward greater independence from international financial institutions. Temporary agreements with the International Monetary Fund (IMF) on macroeconomic policy tend, in general, not to be renewed. Moreover, in a move that gained international prominence, Brazil and Argentina prepaid their outstanding debt with the IMF. The recent evolution of some regional accords has been complicated. Indeed, for example the Andean Community has suffered the withdrawal of Venezuela, though partially compensated by Chile. And the Free Trade Area of the Americas (FTAA) project seems to have stalled. In any case, regional integration is still seen as a more attractive option for increasing commerce than bilateral trade agreements with the United States. On the multilateral front, in contrast with the passivity in previous rounds, the New Left governments play an increasingly active role. It is clear now that the negotiations of the Doha Round face a grim future unless developed countries agree to open their agricultural sectors and to eliminate agricultural subsidies..
Exogenous Risks: The Global Imbalances
There are two scenarios that, in our view, should be first explored regarding the likely medium-term evolution of the world economy and its impact on Latin America. The first is characterized by a, say, “soft landing” of the United States’ economy coupled with a continuation of a rather strong growth of the European Union, the Chinese and other Asian economies so that world trade keeps expanding at a relatively solid rate. This scenario implies that the region will face no significant adverse shocks and, thus, its macroeconomic policies will not be particularly challenged. If the boom in commodity prices does not loose impetus, governments in the Southern Cone will continue to be pressed to avoid the appreciation of the real exchange rate. If the expansion of world trade does decline, the whole region will then continue to be pressed to meet the challenge presented by China in international markets, and may implement policies to boost production of tradable goods and value-added services, as well as of commodities and inputs that the Chinese market demands.
The alternative scenario assumes that the fiscal and current account imbalances in the US economy soon become un-manageable, and lead to a recession combined with substantial turmoil in the exchange rate matrix. In this case, the Latin American economies will be dramatically urged to accommodate a fast depreciation of the dollar, a slowdown in its GDP growth, and an increase in interest rates. This adverse scenario will pose a major challenge for macroeconomic policymaking in the region, with some countries most likely unsuccessfully fighting to avoid acute destabilization and recession.
With the exception of Chile’s Concertación, New Left governments in Latin America are recent arrivals on the real practical policymaking arena. Assessing and predicting the impact of their macroeconomic policies is thus an exercise in audacity and of a partial and preliminary nature. With this caveat, it is safe to conclude that so far Latin America’s New Left’s policies are not in a populist, free-spending mode that ignores budgetary constraints. On the contrary, New Left governments have shown strong fiscal prudence, an increasing state intervention in economic affairs and a commitment to avoid the persistent appreciation of the real exchange rate. This is particularly true of governments that, concerned with employment problems, try to stimulate job creation in export-oriented sectors.
Concerning the trade-off between inflation and economic growth, the New Left governments seem inclined to accept – within limits – higher inflation if it is accompanied by higher rates of economic growth. They emphasize the need for macroeconomic policies guided by development goals and not merely by price stabilization. In practice, their approach to achieving key social goals – poverty alleviation, income redistribution – has been gradual. They have not implemented high-impact social measures that run the risk of triggering large fiscal imbalances and debt spirals. Minimum wage increases have been rather reasonable, and trade liberalization measures have not been rolled back. The starkest innovations on policy matters concern relations with international financial institutions and some transnational corporations regarding the distribution of rents in activities that are intensive in the use of mineral resources. To achieve greater degrees of freedom in macroeconomic policymaking, governments have lowered the public debt ratio, rescheduled public debt maturity structures, issued bonds denominated in local currency, and, most notably, run high primary fiscal surpluses to improve debt sustainability.
The constraints that Latin American governments – left-wing and center/right-wing – face are formidable. Radical, drastic changes in macroeconomic policies are likely out of the question, given the weakness of public sector revenues and the commitment to trade liberalization and the free movement of capital flows. Nevertheless, certain changes in the composition of public expenditure, as well as in policies to promote innovation and to develop specific sectors, could lead to very different and positive outcomes in the medium term.
Perhaps the main risk today is having a big gap between what is expected from the New Left governments in terms of social and economic development and what they will actually achieve. A large credibility gap may undermine support for New Left governments, and lead society to push for more radical – left-wing or right-wing – governments. In our view, the Left today in Latin America is in the process of building a new paradigm of economic development policies. Whether it will succeed in doing so is unclear. In other words, and contrary to the opening statement in the title of this essay, the New Left macroeconomic policies seem to be more a case of “new wine in new bottles”. Whether this wine will age gracefully and have a rich and memorable taste or, on the contrary, sour and decay is too early to know.
Latin America: Macroeconomic indicators of selected countries
Source: Authors’ own elaboration based on official data from ECLAC
1. The opinions expressed in this paper are the exclusive responsibility of the authors and may not necessarily coincide with those of the United Nations Organization. This is a revised and updated version of a paper that appeared in the Harvard Review of Latin America.
2. Research Coordinator, Economic Commission for Latin America and the Caribbean, United Nations.
3. Economic Affairs Officer, Economic Commission for Latin America and the Caribbean, United Nations.
4. The term “New Left” is not used in the European sense of the last thirty years, but only to identify the left-of-center governments currently in power in Latin America.
5. Ricardo Hausmann (2006) recently stated in the Council of the Americas that voters in Latin America tend to shift to political options based on heterodox economic programs, concerned with distribution, when the terms-of-trade of their primary commodities and mineral resources are high. And, analogously he claimed that they favor more orthodox stabilization policies in times of economic slowdown and high inflation.
6. Bolivia’s launched an Agrarian Reform to redistribute 22 million of unused productive hectares to poor families. It is too early to tell whether these reforms will actually be fully implemented, and what will be their socioeconomic impact.