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Chapter 15
Trade and
Policy Reform
in Latin
America
Learning Objectives
• Describe the strengths, weaknesses, and
reasons for import substitution
industrialization.
• Explain the strategy and performance of
economic populism.
• Give the main reasons for the debt crisis of
the 1980s and analyze its relationship to
ISI.
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Learning Objectives
(cont.)
• Discuss the goals of economic policy
reforms that began in the later 1980s.
• Explain why some Latin American leaders
have become impatient with economic policy
reforms.
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Introduction: Defining a “Latin
American” Economy
• A “Latin American” economy is considered
“all of the Americas south of the United
States” (Webster’s dictionary)
• However, Latin America is quite diverse, and
one needs to be careful not to overgeneralize
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Population, Income,
and Economic Growth
• For long stretches of the 20th 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
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TABLE 15.1 Population and GDP for
Latin America and the Caribbean, 2010
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TABLE 15.1 (continued) Population and
GDP for Latin America and the
Caribbean, 2010
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TABLE 15.1 (continued) Population and
GDP for Latin America and the
Caribbean, 2010
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Import Substitution Industrialization:
Origins and Goals of ISI
• Economic policy reform in Latin America
brought the demise of the economic
development strategy known as import
substitution industrialization (ISI)
• ISI shifts policies from outward, export
orientation toward an inward, targeted
industrial strategy
• ISI is a form of industrial policy that focuses
on those industries that produce substitutes
for imported goods
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Import Substitution Industrialization:
Origins and Goals of ISI (cont.)
• Terms of trade (TOT): (index of export
prices)/(index of import prices)
• Argentine economist, Raul Prebisch and a
German exile, Hans Singer argued that
coffee, tin, copper, bananas, and other
primary commodity exports would
inevitably experience price declines relative
to the prices paid for manufactured goods
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Import Substitution Industrialization:
Origins and Goals of ISI (cont.)
• 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
• Export pessimism formed the basis of
orthodox economic policy from roughly the
1950s through the 1970s
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Criticisms of Import Substitution
Industrialization
• 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
• ISI trade and competition policies were
heavily protectionist and often favored the
creation of domestic monopolies
• ISI fostered rent-seeking and corruption
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Macroeconomic Instability
and Economic Populism
• Many Latin America specialists blame faulty
macroeconomic policies on populist or
economic populist political movements
• 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
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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
• “reactivating, redistributing, and
restructuring”
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Stages of Populist Policies
• Economic stimulus through government
expenditures and printing money
• Creation of bottlenecks
• Increase in prices and budget deficits/debt
• Acceleration of inflation
• Pervasive shortages become pervasive
• Capital flight and decline in wages
• Resort to IMF intervention
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TABLE 15.2 Economic Indicators
during the Garcia Administration
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The Debt Crisis of the 1980s
Causes of the Debt Crisis:
•Collapse of world oil prices (Mexico
particularly affected)
•Increase in international interest rates
•Longstanding political mismanagement
•High rates of lending in 1974–1982
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TABLE 15.3 Debt Indicators at the
Onset of the Debt Crisis, 1983
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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
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Neoliberal Policy Reform and the
Washington Consensus
• In the late 1980s, Latin America launched
economic policy reforms that began to alter
the fundamental relationships between
business and government and between
their national economy and the world.
– The region adopted a neoliberal model or
neoliberalism favoring free markets and
minimal government intervention in the
economy
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Neoliberal Policy Reform and the
Washington Consensus (cont.)
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
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Neoliberal Policy Reform and the
Washington Consensus (cont.)
• These reforms came to be known as the
Washington Consensus on policy reform
• Both the neoliberal agenda and the
Washington Consensus were considered
policy prescriptions for reform of
government finances and management of
the economy
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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
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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
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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
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TABLE 15.4 Inflation Rates,
1982–1992
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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
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Structural Reform and Open
Trade (cont.)
• In 1970s Chile began to reform its trade
policies
• In 1985 and 1986 Mexico and Bolivia
followed
• In the late 1980s and early 1990s, nearly all
the countries of Latin America began
reducing both the level of tariffs and
nontariff barriers (NTBs)
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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
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Regional Trade Blocs in Latin
America
• Latin America has many regional trade agreements;
some of the oldest
• NAFTA was implemented January 1, 1994
• December ‘94, thirty-four countries in the Western
Hemisphere committed to a Free Trade Area of the
Americas (FTAA) no later than 2005
• By 2002, the FTAA idea was nearly dead, but Latin
American countries have continued to sign bilateral
and plurilateral agreements
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TABLE 15.5 Average Tariff Rates, in
Percents, Selected Countries
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Table 15.6 Regional Trade Blocs
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The Next Generation of Reforms
• Both Neoliberalism and Washington
Consensus viewed negatively by many Latin
American citizens
- reforms of the last two decades have created
uncertainty and change
- have not begun to fulfill expectations of growth and
prosperity.
• More moderate reformers developing a
second generation of reforms
– take into account the region’s institutions
– address the problems of social and economic
inequality
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The Next Generation of Reforms
(cont.)
• Mechanisms for addressing Latin America’s
highly unequal distribution of income
• Greater emphasis on primary education and
health care for children
• A set of social policies called conditional
cash transfers (CCT)
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The Next Generation of Reforms
(cont.)
• A few Latin American countries, including
Mexico and Chile, have become the most
open and outward oriented of countries
anywhere
• Results elsewhere have been disappointing
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