EconSouth (Second Quarter 2002)
In Search of Better Reform in Latin America
The reforms implemented in Latin America have helped build a solid foundation for growth, but the economic realities have been disappointing for many citizens. What’s wrong with reform, and, more importantly, can it be fixed?
he motivation behind economic reforms in Latin America has been the belief that such reforms will improve living standards after years of high inflation and stagnation in output growth. After a decade or more of reform, many countries can point to some significant accomplishments. Lower tariff structures have made many Latin American economies more competitive, allowed citizens better access to a greater variety of goods and services, and helped attract large-scale foreign investment to the region’s emerging market economies. The continued lowering of inflation in most countries also contributes to overall economic stability.
Yet the results of reform have been somewhat disappointing, and much remains to be done on this far-reaching reform agenda. It is precisely the disconnect between solid economic gains and the enacted structural reforms that fosters many Latin Americans’ “reform fatigue” — a disillusionment with economic reforms due to a perceived lack of gains. This sentiment has led to the concern that growing public dissatisfaction will thwart further reform efforts and ultimately push the region into further economic decay.
Increased dissatisfaction with reform outcomes is reflected in public opinion surveys, which now encompass all the countries in the region and can be consistently and reliably monitored. Since 1997 many of the region’s citizens have expressed growing pessimism about the state of the economy and rising dissatisfaction with the results of reform, and these negative views are becoming more widespread. A 2001 survey found that two-thirds of respondents with secondary and technical education felt that the privatization process has not been beneficial — up from around 45 percent in 1998. The views of those on the two ends of the educational spectrum were more favorable, but dissatisfaction has also increased among these two groups.
While Latin Americans continue to enjoy some of the benefits of economic reform such as low inflation, it is easy to find evidence of its citizens’ disillusionment with the overall progress of reform. Growth has been low or stagnant in many countries even as these nations achieved difficult reforms. The objectives of reform in Latin America are strongly supported, but there is a growing awareness that the costs of reform must be tallied alongside the total benefits. For example, transitioning from closed to open economies by lowering tariff rates for imported products also meant that many previously sheltered domestic industries were wiped out by more competitive imports. Similarly, reducing public expenditure also meant slashing or privatizing public services, making them more expensive or nonexistent. While these reforms promoted competitiveness, they also resulted in a loss of jobs for some workers, who probably found little welfare assistance or worker retraining from cash-strapped governments.
Volatility breeds economic uncertainty
An important component of the overall problems facing the region is economic volatility. The growth rate of regional economies tends to oscillate to such a degree that it often brings economic expansions to a full stop rather than fostering a more gradual decline. During these periods, the inflow of government revenue screeches to a halt and causes severe problems for public spending. Lacking alternatives, the governments’ inability to provide a countercyclical stimulus tends to perpetuate the economic downturn. The region has always been vulnerable to large, external economic shocks. In this regard, economic reforms have been something of a double-edged sword. While reforms strengthen economic fundamentals by disciplining public finances and promoting competitiveness, they also tend to make economies more vulnerable to external shocks as they become more open to external trade and finance.
The persistence of low economic growth rates is central to the problem. As chart 1 demonstrates, the average annual growth rate in gross domestic product (GDP) in the 1990s of 3 percent within the Latin American economies was relatively low. While this performance was an improvement over the previous, so-called lost decade, when hyperinflation and economic stagnation pervaded much of Latin America, the region still managed an average growth rate of 2 percent during the 1980s. Both of these rates were very low compared with the 1970s, when fiscal stimulus and profligate spending pushed the average growth rate to nearly 6 percent per year.
Chart 1 also shows how Latin America has performed compared to developing countries as a whole. The region’s growth rate fell behind over the decades and never regained its previous strength. Even though Latin America’s growth rate was slightly higher than the average for developing countries during the 1970s, it fell off by nearly two-thirds in the 1980s while developing countries in general — including the fast-growing nations in Asia — fell by much less. During the 1990s, the difference in the growth rates was effectively the same even as both regions grew at a higher rate.
Per capita growth presents an equally discouraging picture. Performance was startlingly weak at the aggregate regional level with average per capita GDP growth of 1.5 percent during the 1990s. Chile and the Dominican Republic were the only countries to experience solid per capita economic growth, expanding by an average rate of 4.5 and 4.0 percent, respectively. Cuba, Ecuador, Haiti and Paraguay had negative per capita GDP growth. Per capita growth in Argentina would have been among the highest in the region if not for the recession beginning in 1999. The country’s average per capita income growth between 1991 and 1998 was 4.4 percent, which includes a sharp 4.1 percent drop in 1995 after the peso crisis that originated in Mexico and reverberated throughout Argentina.
Wages grew even less than per capita GDP over the course of the 1990s. Inflation-adjusted earnings ended the 1990s flat compared to the beginning of the decade (see chart 2). Clearly, some gains occurred during the same period, notably the peak in 1992. But this wage peak and the subsequent drop in the second half of the decade points out the ephemeral nature of these gains. The region’s vulnerability to external shocks can also be seen in the sharp wage decline after the December 1994 peso crisis in Mexico and then again after the Asian, Russian and Brazilian crises of 1998 and 1999.
Poverty’s spreading blight
Another important component of the reform fatigue issue is the apparent spread of poverty in Latin America. Chart 3 shows that both the share of households and the population as a whole living in poverty have risen overall since 1980. Particularly notable is the fact that the share of the population living in poverty increased more than 3 percentage points over the course of two decades. Poverty had increased even further when it was measured in 1990 and 1994 before ebbing downward. Nearly half of the population in the region was considered poor in 1990. This number improved for much of the 1990s before trending back up by 1999 to an even higher level than in 1980.
If only the 1990s, the period most closely associated with economic reform, are considered, performance has improved as both the percentage of households and the population overall living in poverty decreased substantially. In absolute terms, however, the number of persons in the region living in poverty increased approximately 6 percent between 1990 and 1999, from 200 million to 211 million people. Likewise, the number of households considered poor rose 5 percent, increasing from 39 million households at the start of the decade to 41 million at the end. While these levels are well below the total population growth, which expanded 16 percent during the same period, the reality is that nearly one in three people added to the population was considered poor. The rise in the absolute number of poor may tend to reinforce the perception that poverty has grown even as the percentage of the poor in the total population declined in the 1990s.
It is important to note that the poverty level in Latin America is calculated as the cost of basic nutritional needs and nonfood basic necessities. While the actual poverty level varies by country, the standard of wealth in Latin America is much lower than the U.S. standard (see the sidebar).
Many citizens have also been disappointed by the failure to improve income distribution in the region. The Gini coefficient, which measures the extent to which actual income distribution differs from an equal distribution of income, was worse at the end of the decade for most countries than it had been in 1990. In fact, Latin American countries have some of the most distorted income distributions in the world. Even Chile, the country with the highest growth rate, saw no real improvement in income distribution over the period. The situation was most acute in Brazil, which has one of the worst income distributions in the world. Data for 1997 show that the lowest of Brazil’s income quintiles (measures divided into five equal parts) received only 2.6 percent of national income while the highest quintile received 63 percent.
Certainly, unequal income distribution is not a new phenomenon in Latin America, but it is another reason why economic reform is often unpopular. A study by the Inter-American Development Bank showed that the difference between the income of the region’s poorest and the richest citizens has become increasingly polarized during the reform period. The study estimates that the income of the richest 1 percent of the population was 363 times higher than that of the poorest 1 percent in 1970. Using measurements every five years, this ratio decreased (that is, improved) in both 1975 and 1980 but began to deteriorate in 1985. In 1990, the richest 1 percent of the population earned 361 times more than the poorest 1 percent, and by 1995 the ratio had increased to 417.
There is no doubt that the region’s wealth and opportunities are limited because its GDP growth rate has fallen behind the average for all developing nations. In other important regards, however, Latin Americans enjoy greater levels of development than other regions — although this difference has been narrowing. The United Nations’ Human Development Index (HDI), which measures life expectancy, educational attainment and income, is often used as an indicator of the level of well-being in a country. According to the HDI, a sample of four Latin American nations — Argentina, Brazil, Chile and Mexico — enjoyed higher results than a similar sample from the developing Asian nations of China, Indonesia, South Korea and Thailand. In 1980, the average HDI score for these four Latin American countries was nearly 20 percent higher than that of the four Asian nations. Although Latin America scored higher in 1990 and again in 1999, the difference between the two regions narrowed sharply. The score for the Latin American countries was 10 percent higher than for the Asian nations in 1990, but by 1999 it was only 6 percent higher.
Generally, however, while inflation is down and foreign investment has increased, many Latin Americans are frustrated and discouraged by continued low and volatile growth, stagnant wages, poverty and dismal income distribution, and a decrease in the pace of human development gains.
What’s next for reform?
The future status of economic reform in Latin America is clouded. Clearly, the outcomes of reform have been mixed. Part of the problem may be that economic reform involves more than changing the set of policies that govern the economy. For reform to be fully successful, it also requires a restructuring of the legal and institutional framework to support economic changes over the long term.
Unfortunately, many of the original architects of reform apparently did not understand the value of the institutional component of reform. As a result, institutional reforms have for the most part not yet been accomplished. For example, restructuring a country’s entire legal code to discourage tax evasion and corruption will take longer to implement than selling a state-owned company, suggesting that the benefits of this next tier of reforms will take much longer to realize. The changes in policies and ownership that occurred in the 1990s were relatively swift by comparison.
Today a great deal of research is under way investigating the relationship between growth and equity. There is growing debate over whether the positive effects of reform on economic goals such as growth, productivity and investment endure over decades or tend more to provide short-term boosts. Economic growth in Latin America was higher on average in the 1990s (3 percent), as countries throughout the region enacted reforms, than in the previous decade (2.1 percent). But some studies show that countries tend to grow faster in the period shortly after reforms are passed, and then growth falls off along with the pace of reform. Obviously, macroeconomic stability reinforces and promotes these gains. Research also indicates that the effect of reform is greater in countries with better legal and institutional environments. Policymakers are increasingly focusing their attention on these areas.
Yet leaders in Latin America today must face these challenges in an environment of macroeconomic instability, declining public support for reform and growing inequality. Recent riots against a succession of governments in Argentina and political upheaval in Venezuela are testimony that these are very real concerns with potentially tragic consequences.
One of the difficulties in diagnosing problems with reform and deciding how to fix them is the shortage of positive examples. Chile’s experience with economic reform has been quite positive in terms of realigning the economy along a path of growth, lower inflation and improved fundamentals. However, reform in Chile has been going on for over two decades, and the initial reform measures were implemented by a dictatorship. Furthermore, the country’s income distribution has not improved. The gains in other countries tend to be much shorter in duration if not episodic, making it difficult to identify the best reforms and enact them in the sequence that promotes economic growth and improved income distribution.
Certainly, the region’s inhabitants support the reform goals of lower inflation, stronger economic growth, a quality public sector and an improved standard of living. The dilemma for policymakers is how to continue to promote these gains while making the reform model more growth-oriented and ensuring that the benefits reach more citizens. Only then will the promise of economic reform — that is, a better life for Latin Americans — be fully realized.
This article was written by Elizabeth McQuerry, coordinator of the Atlanta Fed’s Latin America Research Group.