Spotlight: Latin America's New Economic Strategy

▪ 1995

      In the 1990s the great majority of Latin-American countries changed rapidly from the kind of economic strategy that many of them had been following since the Great Depression of the 1920s and '30s: away from state-led development behind high protective barriers and toward market-determined open economies. At the beginning of 1994 serious questions remained about the degree of public acceptance of this change in the two largest countries in the region, Mexico and Brazil. The doubts were answered positively in both cases. The change was incomplete and remained under active debate, but it moved a long way during the year.

      On Jan. 1, 1994, the North American Free Trade Agreement (NAFTA) took effect, joining Mexico with Canada and the U.S. in a program that opened up free trade in many products, as well as in investment. The agreement allowed a long period of gradual adjustment for agriculture and some specific restrictions in other fields, but for Mexico it was a historic reversal of basic policies that had been in effect since the Mexican Revolution of 1910-20.

      The major question at the beginning of the year was the depth of public opposition from groups that feared either loss of Mexican autonomy or damage to their economic interests. That question was raised in dramatic form by an armed uprising of peasants in the particularly poor state of Chiapas on January 1. The date was chosen to emphasize a connection to NAFTA, but the negotiations that followed came to focus instead on problems of democracy in Mexico, along with issues of land ownership and government neglect of local interests. Meanwhile, Cuauhtémoc Cárdenas, the main opponent of NAFTA in the Mexican presidential election, changed his position to one of questioning particular details rather than objecting to the agreement itself. It was a sign that public acceptance of a more open economy was recognized on all sides.

      Brazil's position was questionable. It had taken steps toward liberalization of trade, but strong public opposition, plus a total breakdown of efforts to hold down the region's highest rate of inflation, made it seem unlikely that Brazil could continue to liberalize. That context changed after the government adopted a new stabilization program, linked by the minister of finance, Fernando Henrique Cardoso (see BIOGRAPHIES (Cardoso, Fernando Henrique )), to a commitment to liberalization. The program proved to have a surprisingly quick effect in cutting inflation and helped to elect Cardoso the new president.

      The particular direction of liberalization emphasized by Cardoso for Brazil differed from that chosen by Mexico. Brazil aimed more at subregional agreements, intended to promote trade between Latin-American countries, than at a general opening to competition with industrialized countries. In August Brazil joined Argentina, Paraguay, and Uruguay in formally signing a customs union: the Southern Cone Common Market, known as Mercosur. In December Chile, the original leader of the movement toward economic liberalization, realized its desire to join this agreement. Meanwhile, Chile pursued the possibility of joining Mexico in an extended version of NAFTA. Bolivia, Colombia, Ecuador, Peru, and Venezuela also began discussions with Mercosur. Separately, Caribbean countries maintained their own association, the Caribbean Community and Common Market, and the Central American countries built on their low-tariff, export-oriented Central American Common Market.

      In 1994 the strains of liberalization proved too great for Venezuela. As in other countries, an austerity program to reduce government deficits, restrain credit, and limit inflation was a vital part of the movement. In Venezuela the austerity program fed so much popular protest—against a government already unpopular for perceived corruption—that the president was forced out of office. The new government, facing many of the same strains, decided to repudiate the austerity program and back away from liberalization.

      No other countries reversed the liberalization process in 1994, but two kinds of strain proved severe for many of them. Strong inflows of capital, in response to liberalization itself and to the high domestic interest rates associated with monetary restraint, often pushed up the value of national currencies. This made imports cheaper and exports more difficult than they would have been at exchange rates consistent with balanced trade. As a result, the region's exports failed to keep pace with the growth of its imports. This context could be regarded in a positive way; the richer countries were moving capital to Latin America, permitting higher rates of investment and consumption than would have been possible in the absence of the import surplus. It was also a problem for the future. External liabilities were increasing, and the region's exports were not developing in the way needed for sustainable long-term growth.

      The social complications of liberalization were particularly evident in Bolivia, Mexico, and Peru, as they had been in Chile before them. The first years of austerity and liberalization, with intensified competition in previously sheltered industries, resulted in falling real wages, the failures of many firms, and increasing poverty. The distribution of income typically became more unequal. All these countries responded in varied ways to such social strains. Mexico negotiated a joint agreement between labour, business, and the government to restrain price increases while promoting limited but positive changes in real wages. Then it introduced its "Solidarity" program of social spending to generate employment and lessen poverty, financed by sales to private investors of previously state-owned firms. Chile used an alternative kind of negotiation; business was asked to agree to an increase of three percentage points in taxes on profits, to be used exclusively for a social program to provide direct help for the poor and to improve skills of low-income workers. Bolivia was helped by international financing agencies to create an extensive social program that increased employment in community-development programs. Peru, after three years of doing little to stop a rise in poverty, initiated a similar program in 1994.

      More open economic systems were expected to help raise efficiency and incomes in the long run, but the impact in the first few years seemed to be so negative for lower income groups that the international financing agencies sought to accompany liberalization with large-scale social programs. Few people disagreed with the need for such programs, provided the financing could be made available. Intense disagreement continued over the question of whether governments should take direct measures to limit the negative effects of liberalization programs on the poor. Specific actions by governments to counteract effects of the movement toward open economies, however, could conceivably undermine the credibility of the basic strategy and, if mishandled, weaken the economies concerned. Or they could, if handled as well as in Chile, make the consequences of liberalization less unequal and continued public acceptance of the strategy more likely.

      John Sheahan is professor of economics (emeritus) at Williams College, Williamstown, Mass., and the author of Patterns of Development in Latin America: Poverty, Repression, and Economic Strategy.

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