In this workshop, organizers and participants discussed a series of papers using a common conceptual framework based on comparable data sets across seven of the largest Latin American countries, including Bolivia, Brazil, Chile, Ecuador, Mexico and Peru. The analyses were based on rich historical data collected from 1960s to the present.
The 1960s are an interesting starting point for analyses; beginning in this decade, Latin America was plagued by macroeconomic crises including defaults, devaluations, balance of payments crises, and banking crises or sudden stops. Current research suggests that these crises have a strong detrimental effect on output and employment.
Moreover, the events of the last five years made clear that developed economies are not immune to crises. While bad macroeconomic fundamentals like chronic deficits and high public debt appear as potential causes for the crisis, this is not always the case. Expectations and multiplicity may play a key role in these events.
In addition to the case studies, organizers also presented several theoretical papers that examine the role of fiscal and monetary policies and the role of expectations on the probability of the crisis.
The Becker Friedman Institute gratefully acknowledges support for this workshop to Donald R. Wilson, Jr., AB ’88 and Edward R. Allen, PhD ’92, as well as the Center for Latin American Studies at the University of Chicago.
Agenda
Monetary-Fiscal Crises, Reforms, and Reversals in Three Countries
Beginning in the 1950s and 1960s, Peru, Chile, and Argentina experienced remarkably similar trajectories of political and economic upheaval. Peru and Chile are the success stories, stabilizing and enjoying strong growth since the early 1990s; Argentina was a bit of an exception, according to Saki Bigio of Columbia University,.
Bigio presented a paper investigating whether Peru and Chile were “just lucky,” or if there were important reasons why Argentina’s moves were less effective. “It’s very useful to study history and narrative of how reforms were carried out and the political influences behind them,” Bigio said. “Our contribution is to deploy economic theory to parse out why these reforms worked, or didn’t.”
“In the 1950s through the 1970s, all three nations had some form of classic Latin American socialism,” marked by nationalization of key industries, agrarian reform, and massive social programs, Bigio said. This led to massive growth in government expenditures not supported by the tax base, especially in Chile.
All three nations eventually experienced serious deficits, some form of hyperinflation, some form of default, and severe GDP decline, he showed. And all experienced violent political transitions.
Bigio, who grew up in Peru in the late 1980s and 1990s, vividly recalled the outcomes of “really bad policy”: regular power blackouts and frequent bombings, no water, stacks of pesos required for purchases, and long waits to get telephone service or a buy a car. Policy oscillated. “Every government elected seemed to reverse the reforms of the previous one, or return to policies of the past,” he recalled.
Eventually, these nations adopted very similar reforms: new constitutions, fiscal discipline, privatization, social security reform, and central bank independence. All had some form of price controls, minimum wages and tariffs that were reversed through labor and trade reform and a shift to market-based price systems.
Chile stabilized first, starting in 1979 with reforms Pinochet adopted. Fujimori made similar reforms in the 1990s and Peru has enjoyed strong and steady growth ever since.
But Argentina was less stable and suffered a severe decline in 1981 when it left currency convertibility.
Bigio postulated a very simple explanation: Argentina was never capable of implementing successful reforms—a common theme in Tom Sargent’s recent work. The difference boiled down to politics.
“For starters, we have to look at who players are. In Chile, Pinochet was a dictator with virtually no opposition. In Peru, Fujimori took a strong line to tackle terrorism of the Shining Path Maoist insurrection, which made him a popular figure. When Congress opposed his pension reforms, he simply shut down Congress.”
In Argentina, President Carlos Menem had to negotiate reforms with Congress and with strong provincial governors. Local and regional governments in Argentina had more power in determining federal representation. Provincials contributed just 13 percent of national revenue but accounted for 37 percent of federal expenditures, mostly associated with transfers and pensions.
In all three nations, the social safety net of entitlements emerged with the ability to tax, and was used for political leverage, creating a fiscal burden. All three privatized, but in different forms.
“The way to think of this is a pecking-order theory of populism funding,” Bigio concluded. “When each nation ran out of resources, they nationalized resources. When they ran out of those resources, they nationalized pension systems. When they ran out of those resources, they nationalized everything via inflation. “
Over time, there was a similar cascade of reversing reforms.
Discussant Manual Amador of Federal Reserve Bank of Minneapolis said the paper raised the question of what constitutes a successful and sustainable reform. He said it was useful to distinguish between those that only change the state variable and reforms that also change the driving forces in the economy.
He presented a model of an open economy and the political environment, with budget and sustainability constraints that showed that running more debt leads to more economic distortion. Temporary reforms result in temporary economic improvements; it takes political strength to implement the slow, often painful process of permanent reform.
Amador noted the importance of learning, where agents could see benefits of reform and learn from past experiences and neighbors, and the possibility of external incentives to implement reform.
Conference participant Nancy Stokey pointed out a lack of distinction in the work between between policies and political structures. “Learning about policies that work elsewhere doesn’t do much good without political structure reform,” she noted.
View a video of the session here.
The Case of Bolivia
Despite being one of the poorest countries being examined as part of fiscal history project, Bolivia still faced a historical timeline similar to most Latin American nations: revolution, crisis and hyperinflation, heavy nationalization of industry, stabilization and finally growth.
Carlos Gustavo Machicado, presenting his work with Tim Kehoe, said that the pivot points of each of these periods could be traced to shocks both internal and external to the Bolivian economy, with government policy playing an increasingly dramatic role in the direction of the economy as the nation grew older.
The role of debt in Bolivian government evolves along a similar timeline. “During nearly all of its economic history, the Bolivian government ran chronic deficits,” said Machicado. But in the mid-1980s, a hyperinflation crisis made it very difficult for Bolivian authorities to borrow from private creditors, turning instead to bilateral and eventually multilateral creditors to avoid crisis. Since most of this foreign credit came in the form of dollars, the Bolivian economy rapidly moved toward using the dollar, reaching up to 90 percent of all day-to-day transactions. More significantly, as the Bolivian government depended more heavily on foreign lending, they became increasingly bound to honoring foreign debt obligations over time, for fear of losing access to their shrinking sources of external credit.
Government officials moved through several cycles of reform to attempt to reduce their debt through repayment and renegotiation. By 2006, the Bolivian government had nearly all their debt wiped clean, and they were able to stabilize their economy by taking a leading role in the economy via state-owned companies working in the production of domestic oil, electricity, and telecommunications.
Discussant Fernando Alvarez saw some suspect growth accounting in Bolivia’s data. He noted that large amounts of aggregation of all state-owned enterprises made it difficult to discern successes from failures in public investment. Attendees debated the issue at length, but the consensus was expressed by co-author Tim Kehoe. “What’s lacking, and people noticed, is better information on public enterprise deficits. But I don’t think we’re going to get better data.” However, he and Machicado remain hopeful that a new, large dataset direct from the Bolivian government may contain the detail they need to better understand growth in the later periods of Bolivian fiscal history.