Latin America Before the Neo-Liberal Wave

Hi Class,

I know that perhaps I was not as clear as required during my exposition in class today, so I will try to put ideas in order here. I will do this in several parts. First I will try to give you an overall account of the kind of situations that prevailed in Latin America prior to the neo-liberal wave of the late 1980s. In future deliveries, I will address the theory behind market convergence, the change in the role of the State and some of the reasons behind the claim for fiscal discipline.


Latin American Economies at the End of the 1970s


Why Latin America came to be at the mid 1980s such a fertile ground for policies generally associated with neo-liberalism? The answer to such question must be found in the role that the states, the countries' governments assumed after a long period of expansion, during the 1970s. I will use Mexico’s example with some references to other countries in the region.

By the end of the 1960s Mexico was at the end of what was called the “Mexican miracle”. Forty years of internal peace and fifty years without a foreign, either U.S. or European, military intervention had allowed for a series of key changes in the country. The only similar period of internal peace and absence of foreign conflict were the 30 years of Porfirio Díaz as president from 1880 to 1910. As a consequence several key indicators of consumption, wellbeing and public expenditure registered key changes. The country had just hosted the Olympic Games (1968) and the Soccer World Cup (1970). However, social tension existed. That is why we had at the end of the 1960s the awful massacre at Tlaltelolco as the corollary to a series of repressed social mobilizations.

The expansion of the economy had happened under the hypotheses developed right after the Great Depression of 1929, the end of a globalization period itself. The key assumption in Mexico, the rest of Latin America, the US and Europe was that you cannot trust that much global processes of economic integration because a global crisis has devastating consequences. The sound conclusion to such premise was that the state had a key role in shaping policy through what was known as “interventionist” and/or Keynesian (honoring British economist John Maynard Keynes) or expansionist policies.

Keynesian or expansionist policies generally assume that to induce growth or to improve the performance of any given economy it is necessary to increase or to expand (hence their second label) the government's spending. These expansionist policies were behind the recovery of the U.S. economy during the 1930s, but to be successful you must be able to increase the availability of cash, either by printing more bills and/or by lowering the credit rates. Also, you must be ready to deal with inflation.

On the other hand, a good example of interventionist policies in the U.S. are the policies of affirmative action or, as they are called in Europe, “positive discrimination.” Other good examples of such policies are the housing projects developed in large agglomerations like New York. The ideas behind such intervention were, on the one hand, at a general level regardless of the level of development of your country, that the state, the government, was intervening to address a failure or insufficiency in the market.

You can have both policies at the same time (interventionist and expansionist), or as it happens nowadays, only interventionist policies that try to adhere to some notion of fiscal discipline, however back in the 1970s in Latin America almost all programs were both interventionist and expansionist.

The second assumption, specific to Latin American countries, was that such intervention had to develop self sufficient economies, following the criteria that, as one of many possible examples,
Max Weber set in Economy and Society. Hence the need to carry the import substitution policies and, among others, the protectionist policies aimed at guaranteeing the development of a national, self-sufficient, economy.

In Mexico and elsewhere in Latin America those “interventionist” policies took the form of direct and universal subsidies to different goods and services: public health (universal free vaccination, as an example), public education, and so forth and so on. However, and this is relevant to connect the issues considered on the readings on citizenship those policies were implemented with a great doses of clientelism.

In the region "interventionist" policies were almost always coupled with "expansionist" policies. This happened because governments were either unable or unwilling to collect taxes to increase their ability to intervene. Here you can see some of damaging effects of oil revenue. Instead of collecting taxes while carrying an aggressive interventionist program (as is the case of Sweden or Norway), they preferred to either print cheap money or to borrow it from foreign lenders, assuming that commodity markets will go their way. Clientelism was perceived as politically viable precisely because the governments in the region expected to be able to cash in the profits of their commodities.

The Culmination of the Miracle

To illustrate my point I will use the example of the public housing policies developed in Mexico at the beginning of the 1970s. At that time, the Federal Government founded the Instituto del Fondo Nacional de la Vivienda de los Trabajadores (Infonavit, Institute of the National Fund for Worker’s Housing). The idea was to provide cheap housing to the families of workers in the formal circuits of the economy.

Back in those days most unions in the country were part of one of the major workers’ centrals in the country: Central de Trabajadores de México (CTM), Confederación Regional Obrera Campesina (CROC), or were a part of the Worker’s Congress (CT) a federation of unions. However, and here is where the plot thickens, the CTM, the CROC and many other unions were a part of the Workers’ Sector within the ruling Revolutionary Institutional Party (PRI). The workers of the federal government belong up until today to the Federación de Sindicatos de Trabajadores al Servicio del Estado, which was also at that time a part a of the PRI.

Even if the original draft of the law that created the Infonavit proposed a raffle as the mechanism to assign housing to the workers, the labor caucus in the Federal Congress (all of them leaders of some of the major unions affiliated with the Workers’ Congress if not directly with the CTM) decided that such mechanism was not adequate. They decided that the worker must have the approval of his/her union’s leader in order to be eligible for the raffle.

As you can imagine, this kind of mechanism gave all sorts of power to the union leaders to decide who were eligible for that raffle. Ultimately, the beneficiary of such concentration of power was the PRI and its bosses. That mechanism fits nicely within Lucy Taylor’s argument regarding the existence of two mechanisms of political participation in the region’s polities: citizenship and client-ship.

Moreover, the law that created the Infonavit established that all housing units were going to be built by Infonavit itself. You might think well, that is cool, not? Well, not really. The main problem with that kind of approach is that again, as in the case of the football clubs, the government was adding yet another activity to its extensive portfolio of activities. As I mentioned in class, in some cases the government took over bankrupted firms arguing that it was better to preserve the existing jobs, than to let the firms (and the jobs) die. The willingness of the government to take over bankrupted firms made it the owner of professional soccer clubs, bike factories, one bar (El Patio), movie theatres, studios, radio stations, TV networks, and so forth and so on.

This ever growing public sector created problems, due to the size of the government. There is a huge debate about the issue of the size of the organizations. Some assume that large organizations create a series of problems of management because of the “hierarchies” created within such large conglomerates. Those hierarchies make decision making/decision taking a matter of personal and group interest and not a matter of efficiency. Of course, as any thing in this world, there are those who assume that the critiques to large organizations are ideologically biased and that evidence is not conclusive. I personally adhere to the first group. I have carried research in Mexican dioceses, and I have found that, as a rule of thumb, small dioceses where the bishop knows personally his priests and the lay leaders outperform large (arch)dioceses where decisions are made by bureaucrats and where relations between the (arch)bishop and his priests and lay leaders are distant.

Moreover, there is evidence of how, by the end of the 1980s Infonavit (and other similar housing governmental programs as FOVI and Fovissste) had enormous bureaucracies, producing poor quality housing, that often times were unsuitable for living. Take as an example many of the housing units built by Infonavit in states like Veracruz, Tabasco or Guerrero. In those states average temperatures around the year resemble the kind of weather you have here in New York during the summer, with similar levels of humidity. A house or apartment designed following the criteria set by Infonavit for houses in Mexico City (low ceilings with no air conditioning) makes no sense in tropical areas of Mexico where temperatures are extremely hot and humid.

So, not only you had this bureaucratic gateway to decide who were eligible to get housing from Infonavit, FOVI or Fovissste. You also had problems with the quality of the construction and, of course, with the prices set by the government acting as developer or realtor, because being the government the main builder it had a privileged position to set prices. This not to mention all the problems associated with the actual operation of the construction sites, often times full of what was called at the time "ant's robbery" (robo hormiga) or with large scale fraud with the criteria to buy cement, bricks, and other construction materials.

Again, the problem here is not the intentions. The intentions of the government in Mexico were, as almost always is the case, very noble. The problem was the choice of policies to achieve the aims.

Now, this model got a boost in the mid 1970s when, all of the sudden the Mexican petroleum firm Pemex discovered vast oil fields in the states of Tabasco and Campeche. José López Portillo’s government assumed that with the new cash flow from the oil boom at that time (the barrel of petroleum reached a peak after the boycott by Saudi Arabia and other Arab countries) what the country required was not a democratic reform as Luis Echeverria’s government had unsuccessfully tried. What was necessary was a more interventionist government able to provide for all the needs of the population, which in turn will allow appeasing any criticism to his government that, by the way, suffered from the outset because López Portillo ran in 1976 as the sole and uncontested candidate of three different parties (the center-to-right opposition of the Partido Acción Nacional split in a heavily disputed convention and was unable to nominate a candidate).

Once aware of the new riches, López Portillo’s State of the Union address in September 1st 1977 made a call to “manage the abundance” (administrar la abundancia). Since then, and especially after the painful aftermath of his government, the phrase “administrar la abundancia” has been used to make fun of grandiose projects that have unexpected negative consequences.

Tweaking the Peso

Now, as I mentioned in class, other key area of governmental intervention is that of the currency exchange rate. During the 1950s and 1960s the general hypothesis applied in the major economies of the region was that a fixed rate of exchange with the dollar was not only possible but better for the performance of the economy. A fixed exchange rate helps some sectors of the economy (especially those buying technology, machinery, or intermediate goods outside the country), but it hurts other sectors (especially those exporting commodities). Moreover, a fixed rate also has other (unexpected negative) effects. Among them, it subsidizes sumptuary consumption. At some point in Mexico, in the 1960s, as an example, it was cheaper to get a washing machine in Texas than to buy it in Nuevo León, so people had incentives to go to Texas to buy those kind of goods or, even worse, to buy them as contraband in Mexico City.

The situation with contraband in Mexico City in the 1970s was so bad that an entire section of the city (Tepito) became a sort of “free-port,” where the federal and local governments, for reasons connected with corruption of the police corps, decided not to exercise their authority. Similar phenomena happened all over the region. The consequences of this situation were similar to the ones created in the US by the Volstead Act (Alcohol Prohibition). On the one hand, you have a noble but rather unrealistic aim (to protect the Mexican industry or to prevent alcoholism in the US). On the other hand, you have “creative” entrepreneurs willing to challenge the governments’ noble aims. Those “creative” entrepreneurs are known here and in Mexico as organized crime for reasons that are easy to understand.

On top of it were yet more problems. Another way in which governments end up subsidizing sumptuary consumption is the case of those interested in going to spend a holiday week in Paris or here in New York. You will be getting cheap (fixed rate) dollars in Mexican banks to go to Paris to drink champagne or to Manhattan to drink a Manhattan cocktail (remember, I am talking about the 1960s and 1970s). Groovy, isn't it?

Overtime, especially when you are dealing with large quantities of dollars, these kinds of situations create big holes in public finances. You may think, well, lets control who get those cheap subsidized dollars and that is certainly a possibility, but only if you were able to eradicate the black market. Just think that even in Cuba, with the anti-U.S. sentiment and the pressure of Castro’s government to prevent the use of dollars as a mean savings, you still have a black market of U.S. currency, so Mexico with a border as porous as the one we have with your country was unable to do it. That was one of the reasons behind the decision of the government to devaluate the Mexican Peso, first in 1976 and from then on a regular basis: it was impossible for the government to keep subsidizing cheap dollars because almost always you will do it by pulling money from other programs or, what is worst, by printing money. On the other hand, when you keep a fixed exchange rate for a long period your exports will loose competitiveness in the world market. So, again, the plot thickens. How would you as a government be able to bring competitiveness back? You lower the exchange rate, making your exports cheaper. This one was yet another reason behind the decision of the Mexican government to devaluate the Peso in 1976.

The good intentions of keeping the fixed rate originally were to help some sectors of the economy to buy technology and machinery, to provide some sense of order to the entire market. The unexpected negative consequences were that your products (most of them raw materials and commodities) lost competitiveness in the world markets, because over time they became more expensive, and this in spite of the fact that, as Robinson clearly states in his article, the prices of all commodities sold by Latin America were registering significant drops. The problem of course, is why we kept depending on those kinds of exports.

The Road to Hell…

As a way to address those problems new good intentions emerged. Therefore, to regain competitiveness governments changed the exchange rate. But then again, reality came to bite back with a handful of negative unexpected consequences, the most important of them in the form of inflation. Economists will agree that a relatively low inflation rate can have in certain circumstances good effects for the entire economy.

The problem however, comes when inflation goes out of control, and that is not a decision that rests on the government. On the contrary, inflation and especially hyper-inflationary processes as the ones that Argentina, Brazil, Peru and other countries in the region experienced in the late 1970s early to mid 1980s are collective processes where all bets are off. Producers have no way to set in a rational way the prices of their products, so they raise them as much as they can to try to gain some coverage from sudden changes in the market. Unions make constant demands for wages’ increases (strikes and mobilizations included) that makes the entire operation of firms a constant challenge. Rents are set in dollars or adjusted monthly against the dollar or some other indicator (inflation rate, leading lending rate, etc.) so persons with low incomes will have a bad time finding a place to live. At some point, the banks stop lending because the entire operation becomes unmanageable, and the government itself a key economic agent, becomes dependent on relatively cheap new money by either borrowing it (inside or outside the country) or, even worse, by printing it (ab)using its right to coinage.

Also, as I mentioned in class, people in those kinds of circumstances see no benefit from saving. On the contrary, if you get your salary you better go to the store to spend the whole thing in whatever you may need for the rest of the month, because perhaps by the end of the month you will not be able to buy those goods.

Alternatively, if you are able to save, you do it by buying dollars (which is a weird bet against your own currency because ultimately the pressure to devaluate your currency grows). Or, even worse, if you can, you send your money to a U.S. bank to try to protect your savings from confiscatory policies of your own government (depriving your own country of a valuable resource and betting again against your own currency) or if you are Mr. Big Bucks you send it to off-shores, with the same outcome at a larger scale.

Regressive Tax

Now, despite its origins as a policy aimed at controlling key variables of the economy, the cycle of devaluation-inflation has by itself very disturbing consequences for the entire economy. That is why there is a school of economic thought that calls inflation a “regressive tax”. Why? Well, among many other things because people with enough money can protect their savings by converting them overnight to dollars (or back in those days German marks or British pounds). People who are unable to do so keep their income in local currency, running the risk of loosing the value of their assets overnight, as it happened in the hyperinflationary context of Brazil. Moreover, there is ample evidence on how unfair is the allocation of the burden of the inflation is, mainly because it hits harder on those who have little or no chances to save. Here you can read an article on the subject.

In some cases, as in 1976 in Mexico, the devaluation of the currency was announced to acknowledge a series of de facto situations (a huge difference between the official exchange rate and the one in the black market, subsidies to sumptuary consumption, etc.). However, in other cases governments induced this process by increasing the amount of bills and coins available at any given period (hence the relevance of the term coinage, the right that states have to make coins that I used in class) in the economy. With policies like that, all of the sudden you will have a huge amount of pesos, soles or cruzeiros available to buy dollars, giving the entire process yet another hike.

In Mexico in the late 1970s, after the 1976 devaluation and the 1977 announcement of the new oil riches in Tabasco, the government increased on the one hand the amount of bills circulating in the economy. After all, the assumption was that we were going to be floating in a sea of petro-dollars, as they were known at the time. Over time, this situation conflated with the huge borrowing of foreign and domestic debt prompted by the assumption that the country was going to be rich (administrar la abundancia), and with ridiculous patterns of consumption (both by the government, the private firms and individuals) made possible by the sudden influx of cheap petro-dollars and the lack of fiscal discipline. A flash back of Tepito, Mexico City's "free-port" in those years will let you see French wines, European chesses, and even the first models of personal computers displayed in the forefront of the houses of an apparently poor neighborhood.

Of course, not all things from this time were wrong. Mexico City’s underground, as an example, was expanded. New public schools (my own Junior High School and my University!) were built. The Social Security system was expanded (so much that it ended up owning two Premier League soccer teams, Atlante and Oaxtepec). New highways were built all over the country. Also, as an example, a nuclear plant (Laguna Verde) was built.

However, the party came to a sudden stop when the oil prices went down and interest rates in the world markets went up. Floating in debt, ridden with all sorts of problems, in June 1982 the Mexican government was forced to declare itself unable to repay the country’s foreign debt. Three months after it, during his State of the Union address on September 1st 1982, the President nationalized the banking system seizing all accounts in US dollars and blaming the Mexican bankers for the crisis. The problem is that even if it was a sound and much needed policy decision, the way in which López Portillo carried it, as a backlash against greedy bankers and to defend the Nation from a foreign treat, ended up creating more tension.

The decision was perceived by some sectors of the population as a step towards a greater interference from the government in the economy (meaning socialism or communism). Leaders of the private sector presented the measure as confiscatory and abusive. However, and interestingly enough, at the same time, the Chilean military government of Pinochet (hardly a Communist) was taking similar steps, so it was not about Communist López Portillo versus Capitalist Pinochet. It was a measure aimed at protecting their banking systems, the few assets still on them, and to protect the economy from future shocks. However, López Portillo inflamed rhetoric connecting his decision with previous nationalization experiences (the Oil in 1938 and the Electricity in 1960), made him an easy target of fierce critiques from the right. (You can find here an explanation of why it was necessary for Mexico's and Chile's governments to take over the banking systems).

Fortunately, López Portillo was at the end of his six-year term, so a new President and a new team took over in December 1982. The situation, however, continued to deteriorate. The cycle inflation-devaluation was on and the decisions of the government created more uncertainty, so there was a huge pressure to keep hiking prices. Foreign credit was hard to find, and Miguel de la Madrid presided over an intense power struggle within his cabinet.

Moreover, in 1985 a major (8.5) earthquake hit Mexico City. The earthquake, on the one hand, showed how fragile was the country’s economy and the problems that the federal government had to provide answers to situations like that. On the other hand, it was perceived as an awful display of the inability of the Mexican government to help in a crisis context. Moreover, it also created new needs as far as housing and the very reconstruction of the city were concerned, all of which was happening within the context of a relatively intense (although not as much as Brazil’s or Argentina’s) cycle of devaluation-inflation.

The Plans

That is why, at some point in the 1980s, it was unavoidable for the governments either to apply a “shock-plan” or a heterodox plan, the cornerstones of neo-liberalism in the region. The shock plans aimed at freezing at least temporarily the entire economy to try to induce a sudden stop to the (hyper)inflationary processes. That was the case of countries like Argentina and Brazil where the devaluation-inflation cycle reached the two or tree digits level. The “shock-plans” of the 1980s included a sudden reduction in the amount of cash available in the overall economy and/or the adoption of an entirely new currency (the shift from the peso to the austral in Argentina).

Mexico followed a heterodox plan since the government was able to control key prices of the economy (fuel, energy, public sector wages, etc.). The heterodox plan was labeled as the “Pacto de Solidaridad Económica” (Economic Solidarity Pact). The idea was, however, the same of the shock-plan although it was less damaging for the economy: prices will be fixed, unions will not seek increases, and producers will reduce their expectations.

This is the time when the wave of the so-called “neo-liberal” governments happened. In some cases (Mexico) the term was accurate since we had a cohort of relatively young politicians, with Carlos Salinas as their leader, with degrees in Economics from US universities who claimed to be heirs to the old Liberalism of Juárez ("social liberals" called themselves). However, the situation was not the same all over the region.

To be continued...