Professor Alejandro Diaz-Bautista, Economic Policy, Debt Crisis Presentation

Economic Policy in Latin AmericaEconomic Policy in Latin AmericaIRGN 409IRGN 409

April-June, 2008April-June, 2008

The Debt Crisis in Latin America The Debt Crisis in Latin America

Alejandro Díaz-Bautista, Alejandro Díaz-Bautista, Ph.D.Ph.D.

[email protected]@gmail.com

Professor of Economics and Researcher at COLEFVisiting Research Fellow and Guest Scholar 2008, Center for U.S.-Mexican Studies, University of California San Diego (UCSD). April 2, 2008Graduate School of International Relations & Pacific Studies IR/PS University of California, San Diego

Debt Crisis in the 1980’sDebt Crisis in the 1980’s The Latin American debt crisis was a financial crisis that occurred The Latin American debt crisis was a financial crisis that occurred

in the early 1980s (and for some countries starting in the 1970s), in the early 1980s (and for some countries starting in the 1970s), often known as the "lost decade", when Latin American countries often known as the "lost decade", when Latin American countries reached a point where their foreign debt exceeded their earning reached a point where their foreign debt exceeded their earning power and they were not able to repay it.power and they were not able to repay it.

In the 1960s and 1970s many Latin American countries, notably In the 1960s and 1970s many Latin American countries, notably Brazil, Argentina, and Mexico, borrowed huge sums of money from Brazil, Argentina, and Mexico, borrowed huge sums of money from international creditors for industrialization; especially international creditors for industrialization; especially infrastructure programs. infrastructure programs.

Between 1975 and 1982, Latin American debt to commercial Between 1975 and 1982, Latin American debt to commercial banks increased at a cumulative annual rate of 20.4 percent. This banks increased at a cumulative annual rate of 20.4 percent. This heightened borrowing led Latin America to quadruple its external heightened borrowing led Latin America to quadruple its external debt from $75 billion in 1975 to more than $315 billion in 1983, or debt from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region's gross domestic product (GDP).50 percent of the region's gross domestic product (GDP).

Sebastian Edwards (1995) Crisis and Reform in Sebastian Edwards (1995) Crisis and Reform in Latin America: From Despair to Hope. Sebastian Latin America: From Despair to Hope. Sebastian Edwards. Oxford University Press.Edwards. Oxford University Press.

The book is an optimistic overview of the reform The book is an optimistic overview of the reform process in Latin America from 1982 to 1994 by process in Latin America from 1982 to 1994 by the World Bank's chief economist for Latin the World Bank's chief economist for Latin America and the Caribbean and Professor at America and the Caribbean and Professor at UCLA. UCLA.

The book examines economic policymaking, often The book examines economic policymaking, often drawing on the excellent comparative work of drawing on the excellent comparative work of recent years. He recognizes that just as experts recent years. He recognizes that just as experts failed to anticipate the Mexican default of 1982, failed to anticipate the Mexican default of 1982, which set in motion the Latin American debt crisis which set in motion the Latin American debt crisis of the 1980s, they underestimated the depth of of the 1980s, they underestimated the depth of the Mexican peso crisis in December 1994.the Mexican peso crisis in December 1994.

Sebastian Edwards (1995) Crisis and Reform in Sebastian Edwards (1995) Crisis and Reform in Latin America: From Despair to Hope. Sebastian Latin America: From Despair to Hope. Sebastian Edwards. Oxford University Press.Edwards. Oxford University Press.

Edwards acknowledges the role of the debt crisis Edwards acknowledges the role of the debt crisis and outside pressure from the multilateral and outside pressure from the multilateral lending agencies and the United States in lending agencies and the United States in stimulating market reform. Edwards attributes stimulating market reform. Edwards attributes the reform consensus primarily to the failure of the reform consensus primarily to the failure of various stabilization policies (Argentina and various stabilization policies (Argentina and Brazil) and a reinterpretation of the experience in Brazil) and a reinterpretation of the experience in Chile, where antipoverty programs were Chile, where antipoverty programs were combined with market economics after the return combined with market economics after the return

to democracy.to democracy.

The Debt CrisisThe Debt Crisis In the 1980s, the world experienced a debt crisis in which In the 1980s, the world experienced a debt crisis in which

highly indebted Latin America and other developing highly indebted Latin America and other developing regions were unable to repay the debt, asking for help. regions were unable to repay the debt, asking for help.

The problem exploded in August 1982 as Mexico The problem exploded in August 1982 as Mexico declared inability to service its international debt, and declared inability to service its international debt, and the similar problem quickly spread to the rest of the the similar problem quickly spread to the rest of the world. To counter this, macroeconomic tightening and world. To counter this, macroeconomic tightening and "structural adjustment" (with liberalization) were "structural adjustment" (with liberalization) were administered, often through the conditionality of the IMF administered, often through the conditionality of the IMF and the World Bank. This crisis involved long-term and the World Bank. This crisis involved long-term commercial bank debt which was accumulated in the commercial bank debt which was accumulated in the public sector. public sector.

The governments of developing countries were unable to The governments of developing countries were unable to repay the debt, so financial rescue operations became repay the debt, so financial rescue operations became necessary.necessary.

The Paris Club is an informal group of financial officials from 19 of the world's richest The Paris Club is an informal group of financial officials from 19 of the world's richest countries, which provides financial services such as debt restructuring, debt relief, and debt countries, which provides financial services such as debt restructuring, debt relief, and debt cancellation to indebted countries and their creditors. Debtors are often recommended by cancellation to indebted countries and their creditors. Debtors are often recommended by the International Monetary Fund after alternative solutions have failed.the International Monetary Fund after alternative solutions have failed.

It meets every six weeks at the French Ministry of the Economy, Finance, and Industry in It meets every six weeks at the French Ministry of the Economy, Finance, and Industry in Paris.Paris.

Origins of the Debt CrisisOrigins of the Debt Crisis In the 1960s and 1970s many Latin American In the 1960s and 1970s many Latin American

countries, most notably Brazil, Argentina, and Mexico, countries, most notably Brazil, Argentina, and Mexico, borrowed huge sums of money from international borrowed huge sums of money from international creditors in order to foster national industrialization.creditors in order to foster national industrialization.

These countries had growing economies at the time These countries had growing economies at the time so the creditors were happy to continue to provide so the creditors were happy to continue to provide loans. loans.

Between 1975 and 1982, Latin American debt to Between 1975 and 1982, Latin American debt to commercial banks increased at a cumulative annual commercial banks increased at a cumulative annual rate of 20.4 %. rate of 20.4 %.

Increased borrowing led Latin America to quadruple Increased borrowing led Latin America to quadruple its external debt from $75 billion in 1975 to more than its external debt from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region's $315 billion in 1983, or 50 percent of the region's gross domestic product (GDP). gross domestic product (GDP).

Origins of the Debt CrisisOrigins of the Debt Crisis October 30, 1976.October 30, 1976. Mexican Economic Situation.Mexican Economic Situation. Central Intelligence Agency, secret memorandum. Central Intelligence Agency, secret memorandum.

Open Archive, U.S. and Mexican declassified Open Archive, U.S. and Mexican declassified records. records.

This document captures the way the peculiarities This document captures the way the peculiarities of the Mexican political system can exacerbate of the Mexican political system can exacerbate economic crisis. economic crisis.

““Economic policy in Mexico, like any other policy, Economic policy in Mexico, like any other policy, is determined directly by the President.” is determined directly by the President.”

Origins of the Debt CrisisOrigins of the Debt Crisis

José López Portillo y Pacheco (a.k.a. "Jolopo") was the President of Mexico José López Portillo y Pacheco (a.k.a. "Jolopo") was the President of Mexico from 1976 to 1982. Born in Mexico City, López Portillo studied Law at from 1976 to 1982. Born in Mexico City, López Portillo studied Law at UNAM before beginning his political career with the PRI. He held several UNAM before beginning his political career with the PRI. He held several positions in the administrations of his two predecessors before being positions in the administrations of his two predecessors before being appointed to serve as finance minister under Luis Echeverría, a close appointed to serve as finance minister under Luis Echeverría, a close friend, from 1973 to 1975.friend, from 1973 to 1975.

López Portillo promoted Mexico's economic development with revenues López Portillo promoted Mexico's economic development with revenues stemming from the discovery of new petroleum reserves in the states of stemming from the discovery of new petroleum reserves in the states of Veracruz and Tabasco by Pemex, the country's publicly owned oil Veracruz and Tabasco by Pemex, the country's publicly owned oil company.company.

López Portillo undertook actions which were highly controversial with López Portillo undertook actions which were highly controversial with respect to the international banking establishment. One of his last respect to the international banking establishment. One of his last actions as president, announced during his annual State of the Nation actions as president, announced during his annual State of the Nation address on September 1, 1982, was to order the nationalization of the address on September 1, 1982, was to order the nationalization of the country's banking system.country's banking system.

López Portillo was the last nationalist president to emerge from the López Portillo was the last nationalist president to emerge from the ranks of the PRI, and advocate of the ISI Economic Policies. Subsequent ranks of the PRI, and advocate of the ISI Economic Policies. Subsequent presidents have all been U.S.-educated advocates of free trade.presidents have all been U.S.-educated advocates of free trade.

Origins of the Debt Origins of the Debt CrisisCrisis

Famous quotes by Ex President Lopez Portillo.Famous quotes by Ex President Lopez Portillo. ““Defenderé el peso como un perro!” Defenderé el peso como un perro!” Six months earlier, after promising to defend the peso Six months earlier, after promising to defend the peso

"like a dog", López Portillo devalued the national "like a dog", López Portillo devalued the national currency by 40%. After leaving office, he was reportedly currency by 40%. After leaving office, he was reportedly unable to appear in public without being barked at, and unable to appear in public without being barked at, and his luxury, five-mansion became known as Dog Hill. his luxury, five-mansion became known as Dog Hill.

En el mundo de la economía los paises se dividen en En el mundo de la economía los paises se dividen en dos: los que tienen petróleo y los que no lo tienen. ¡Y dos: los que tienen petróleo y los que no lo tienen. ¡Y nosotros lo tenemos! nosotros lo tenemos!

"In the world economy, countries are divided in two: "In the world economy, countries are divided in two: those that have oil and those that don't have it. And we those that have oil and those that don't have it. And we have it!" have it!"

López Portillo six-year term of office, from López Portillo six-year term of office, from 1976 to 1982, coincided with the discovery 1976 to 1982, coincided with the discovery of massive oil reserves and the tripling of of massive oil reserves and the tripling of oil production, raising Mexico to the status oil production, raising Mexico to the status of the world's fourth biggest producer. This of the world's fourth biggest producer. This stimulated uncontrolled government stimulated uncontrolled government spending and foreign borrowing. When the spending and foreign borrowing. When the economy overheated and the oil price fell, economy overheated and the oil price fell, the country was hit by capital flight and the country was hit by capital flight and the debt crisis started.the debt crisis started.

Start of the Debt CrisisStart of the Debt Crisis As interest rates increased in the US and in Europe in 1979, As interest rates increased in the US and in Europe in 1979,

debt payments also increased making it harder for borrowing debt payments also increased making it harder for borrowing countries in Latin America to pay back their debts. countries in Latin America to pay back their debts.

While the dangerous accumulation of foreign debt occurred While the dangerous accumulation of foreign debt occurred over a span of years, the debt crisis began when the over a span of years, the debt crisis began when the international capital markets became aware that Latin America international capital markets became aware that Latin America would not be able to pay back its loans. would not be able to pay back its loans.

This occurred in August of 1982, when Mexico's Finance This occurred in August of 1982, when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no Minister, Jesus Silva-Herzog declared that Mexico would no longer be able to service its debt. In the wake of Mexico's longer be able to service its debt. In the wake of Mexico's default, most commercial banks reduced significantly or default, most commercial banks reduced significantly or stopped new lending to Latin America. stopped new lending to Latin America.

Much of Latin America's loans were short-term, causing a crisis Much of Latin America's loans were short-term, causing a crisis when their refinancing was refused. Billions of dollars of loans when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced, were now due that previously would have been refinanced, were now due immediately.immediately.

1982 Mexico Debt 1982 Mexico Debt CrisisCrisis

By mid-1981, Mexico had falling oil prices, higher By mid-1981, Mexico had falling oil prices, higher world interest rates, rising inflation, an world interest rates, rising inflation, an overvalued peso, and a deteriorating balance of overvalued peso, and a deteriorating balance of payments spurred massive capital flight. payments spurred massive capital flight.

This disequilibrium, along with the virtual This disequilibrium, along with the virtual disappearance of Mexico's international reserves, disappearance of Mexico's international reserves, by the end of 1982, forced the government to by the end of 1982, forced the government to devalue the peso three times during 1982. The devalue the peso three times during 1982. The devaluation further fueled inflation and prevented devaluation further fueled inflation and prevented short-term recovery. The devaluations depressed short-term recovery. The devaluations depressed real wages and increased the private sector's real wages and increased the private sector's burden in servicing its dollar-denominated debt. burden in servicing its dollar-denominated debt.

1982 Mexico Debt Crisis1982 Mexico Debt Crisis Cut off from credit, the government Cut off from credit, the government

declared an involuntary moratorium on declared an involuntary moratorium on debt payments in August 1982, and the debt payments in August 1982, and the following month it announced the following month it announced the nationalization of Mexico's private banking nationalization of Mexico's private banking system.system.

By late 1982, incoming President Miguel By late 1982, incoming President Miguel de la Madrid had to reduce public de la Madrid had to reduce public spending drastically, stimulate exports, spending drastically, stimulate exports, and foster economic growth to balance the and foster economic growth to balance the national accounts. national accounts.

Export Oriented Economic Export Oriented Economic

Policies substitute ISI in Latin AmericaPolicies substitute ISI in Latin America In response to the crisis most nations In response to the crisis most nations

abandoned their Import Substitution abandoned their Import Substitution Industrialization (ISI) models of Industrialization (ISI) models of economy and adopted an export-economy and adopted an export-oriented industrialization strategy, oriented industrialization strategy, usually the neoliberal strategy usually the neoliberal strategy encouraged by the IMF.encouraged by the IMF.

1982 Mexico Debt Crisis1982 Mexico Debt Crisis Mexico's GDP grew at an average rate of Mexico's GDP grew at an average rate of

just 0.1 percent per year between 1983 just 0.1 percent per year between 1983 and 1988, while inflation stayed extremely and 1988, while inflation stayed extremely high. high.

Total investment fell at an average annual Total investment fell at an average annual rate of 4 %. rate of 4 %.

Throughout the 1980s, the productive Throughout the 1980s, the productive sectors of the economy contributed a sectors of the economy contributed a decreasing share to GDP, while the decreasing share to GDP, while the services sectors expanded their share, services sectors expanded their share, reflecting the rapid growth of the informal reflecting the rapid growth of the informal economy.economy.

1982 Mexico Debt Crisis1982 Mexico Debt Crisis

Getting out of the Debt CrisisGetting out of the Debt Crisis

Several trade policies before NAFTA, Several trade policies before NAFTA, were aimed at expanding trade and were aimed at expanding trade and inducing growth in Mexico. The De la inducing growth in Mexico. The De la Madrid and Salinas de Gortari Madrid and Salinas de Gortari administrations implemented administrations implemented substantial unilateral trade substantial unilateral trade liberalization policies before NAFTA. liberalization policies before NAFTA.

Economic Regression Analysis of Economic Regression Analysis of Mexico in the 80’s and 90’sMexico in the 80’s and 90’s

We can use regression analysis, to study the We can use regression analysis, to study the importance of openness on the rapid growth of importance of openness on the rapid growth of Mexican trade since the 80’s. Trade liberalization Mexican trade since the 80’s. Trade liberalization began with Mexico's unilateral reduction and began with Mexico's unilateral reduction and homogenization of import tariffs, implemented by homogenization of import tariffs, implemented by the administrations of Presidents de la Madrid the administrations of Presidents de la Madrid and Salinas de Gortari. The reduction of import and Salinas de Gortari. The reduction of import tariffs were followed by reductions of trade and tariffs were followed by reductions of trade and investment barriers through the NAFTA investment barriers through the NAFTA framework. A dummy variable with value one is framework. A dummy variable with value one is created since 1986 to 1998 represent unilateral created since 1986 to 1998 represent unilateral trade liberalization and a dummy variable with trade liberalization and a dummy variable with value one is created for 1994 to 1999 in order to value one is created for 1994 to 1999 in order to represent NAFTA’s contribution to liberalization. represent NAFTA’s contribution to liberalization.

Economic Regression Analysis of Economic Regression Analysis of Mexico in the 80’s and 90’sMexico in the 80’s and 90’s

We can compare the impact of these two We can compare the impact of these two trade openness policies compared against trade openness policies compared against the autarky period of the previous stage the autarky period of the previous stage (1970-1982). We can control for the effect (1970-1982). We can control for the effect of exchange rate policies with the variable of exchange rate policies with the variable showing the devaluation of the Mexican showing the devaluation of the Mexican peso. Two alternative measures of peso. Two alternative measures of devaluation are used, the rate of change devaluation are used, the rate of change of the nominal exchange rate, and a of the nominal exchange rate, and a dummy variable with value 1 for years dummy variable with value 1 for years when the rate of change was larger than when the rate of change was larger than 50%.50%.

Table 1. TSLS Regression Results (1970-1999) Dependent Variable: Growth Rate in Real Per Capita GDP in Mexico

Independent Variables/ Regressions 1 2 3 Intercept 18.220

(10.911) 18.171

(10.271) 18.920

(10.701) Reforms of de la Madrid & Salinas Administrations

11.216* (4.659)

11.518* (4.060)

11.499* (4.221)

NAFTA implementation and Zedillo 21.563* (4.672)

21.293* (6.582)

20.934* (6.534)

Nominal Devaluation Rate, % 0.017 (0.600)

Devaluation dummy* Liberalization Period 0.420 (0.120)

R2, adjusted 0.795 0.790 0.787 Note: t-values in parenthesis. . *Significant at probability values larger than 95%. Data Sources: INEGI and Bank of Mexico.

Table 2. TSLS Regression Results (1970-1999) Dependent Variable: Natural Log of Openness of Mexico’s Economy (X+M)/GNP

Independent Variables 1 2 Intercept 2.894

(55.920) 2.879

(54.181)

Reforms of de la Madrid & Salinas 0.505* (5.609)

0.470* (5.762)

NAFTA implementation & Zedillo

0.517* (4.140)

0.540* (5.305)

Nominal Devaluation Rate, % 0.001 (1.174)

R2, adjusted 0.806 0.829 Note: *Statically significant at probability values larger than 95%. t-values in ( ). Regression 2 includes the nominal devaluation rate. Data Sources: INEGI and Bank of Mexico.

Regression ResultsRegression Results

Diaz-Bautista (2003) empirical Diaz-Bautista (2003) empirical analysis and regression results analysis and regression results supports the proposition that supports the proposition that unilateral trade reforms and NAFTA unilateral trade reforms and NAFTA have been effective in expanding have been effective in expanding Mexican trade and economic growth.Mexican trade and economic growth.

What led to the debt crisis of theWhat led to the debt crisis of the1980’s in Argentina?1980’s in Argentina?

Corruption and politically unstable Corruption and politically unstable country ruled by a military regime country ruled by a military regime leftover from the 1970’s that retarded leftover from the 1970’s that retarded economic growth and investment.economic growth and investment.

Heavy regulated ISI economy and Heavy regulated ISI economy and government support for inefficient government support for inefficient businesses with subsidies.businesses with subsidies.

Overvalued Argentine peso and out of Overvalued Argentine peso and out of control government budget.control government budget.

What were the economic impacts caused What were the economic impacts caused by the debt crisis during the 1980’s in by the debt crisis during the 1980’s in Argentina?Argentina?

Hyperinflation reaching recorded high of Hyperinflation reaching recorded high of 4900% in 1989 from excess money supply to 4900% in 1989 from excess money supply to finance an inefficient government.finance an inefficient government.

Financial instability of the Argentine peso in Financial instability of the Argentine peso in the 1980’s because of extensive dollar the 1980’s because of extensive dollar denominated debts and rise in interest rates.denominated debts and rise in interest rates.

Price level Argentina 1980-1995

4923.5

1343.9

385.4688.0 387.7433.7209.7 174.887.6 131.3 81.9 84.0 17.5 7.4 3.9 1.60.0

1000.0

2000.0

3000.0

4000.0

5000.0

6000.0

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Source: Roberto Frenkel. Principal Researcher Associate at the Centro de Estudios de Estado y Sociedad (CEDES) and Professor at the Universidad de

Buenos Aires (Graph 1)

Price

Lev

elThe impact of Inflation in ArgentinaThe impact of Inflation in Argentina

• Rapid rising unemployment during the late 1980’s.

• Slow and erratic economic growth with negative gross domestic product GDP during the mid 1980’s.

• Argentina became a debtor nation during most of the decade because of a negative current account balance.

What were the economic impacts caused by the debt crisis during the 1980’s in Argentina?

How did Argentina solve the Debt crisis of the 1980’s?

• In 1991, Argentina implemented radical monetary reforms which pegged the Argentine peso to the United States dollar and limited the growth in the monetary base by law to the growth in reserves. Inflation fell sharply in subsequent years. The 1991 "Convertibility Law" (Ley de Convertibilidad) established a quasi-currency board.

• This was necessary to stabilize the export and import sectors and a prevent a further depreciating Argentine peso.

Reduced production in the public sector by Reduced production in the public sector by Privatizing state owned business and reducing or Privatizing state owned business and reducing or eliminating government subsidies. In 1991 eliminating government subsidies. In 1991 Argentina reduced barriers to trade and Argentina reduced barriers to trade and implemented tax reforms. implemented tax reforms.

Things stared to improve for Argentina which Things stared to improve for Argentina which witnessed growth of its gross domestic product witnessed growth of its gross domestic product GDP during the early 1990’s and inflation GDP during the early 1990’s and inflation declining to 0.2% in 1996.declining to 0.2% in 1996.

However, foreign debt remained a problem which However, foreign debt remained a problem which Argentina’s Current account deficit increased to Argentina’s Current account deficit increased to --$8,370$8,370 millionmillion by 1992. by 1992.

How did Argentina solve the Debt crisis of the 1980’s?

ParaguayParaguay

Population (2005) Population (2005) 6,158,000 (101st) 6,158,000 (101st) GDP (PPP) 2005 estimate GDP (PPP) 2005 estimate Total $28,342 billion (96th) Total $28,342 billion (96th) Per capita $4,555 (107th) Per capita $4,555 (107th) HDI (2007)= 0.755 HDI (2007)= 0.755 Currency: Guaraní (PYG) Currency: Guaraní (PYG)

ParaguayParaguay Paraguay weathered the Latin American debt crisis of the Paraguay weathered the Latin American debt crisis of the

1980s rather well. 1980s rather well. As the fastest growing economy in Latin America for most of As the fastest growing economy in Latin America for most of

the 1970s, Paraguay prospered while many of its neighbors the 1970s, Paraguay prospered while many of its neighbors struggled. Paraguay's debt grew from under US$200 million struggled. Paraguay's debt grew from under US$200 million in 1972 to US$842 million by 1980, but with rapid growth in in 1972 to US$842 million by 1980, but with rapid growth in GDP, debt as a percentage of GDP remained low at GDP, debt as a percentage of GDP remained low at approximately 15 %. approximately 15 %.

Unlike many neighboring economies in the 1970s, which Unlike many neighboring economies in the 1970s, which borrowed to compensate for balance-of-payments deficits or borrowed to compensate for balance-of-payments deficits or inefficient state-owned enterprises, Paraguay's minimal inefficient state-owned enterprises, Paraguay's minimal lending generally went toward productive investment in lending generally went toward productive investment in infrastructure, hydroelectricity, and agriculture. infrastructure, hydroelectricity, and agriculture.

About 80 percent of Paraguay's debt was with official About 80 percent of Paraguay's debt was with official creditors, not commercial banks, allowing for greater creditors, not commercial banks, allowing for greater flexibility and more favorable terms of loan repayment. flexibility and more favorable terms of loan repayment.

Latin America as a region, owed more than 70 percent of its Latin America as a region, owed more than 70 percent of its debt to commercial banks in 1987. debt to commercial banks in 1987.

Paraguay’s Debt in the 1980’sParaguay’s Debt in the 1980’s

Paraguay's debt, however, grew rapidly in the 1980s, at Paraguay's debt, however, grew rapidly in the 1980s, at the second fastest rate in Latin America. the second fastest rate in Latin America.

From 1980 to 1987, Paraguay's indebtedness more than From 1980 to 1987, Paraguay's indebtedness more than doubled, to roughly US$2 billion. Because of Paraguay's doubled, to roughly US$2 billion. Because of Paraguay's slow economic growth during that period, debt as a slow economic growth during that period, debt as a percentage of GDP increased to above 50 percent. percentage of GDP increased to above 50 percent.

Paraguay's rapidly growing debt in the 1980s mirrored Paraguay's rapidly growing debt in the 1980s mirrored that of its neighbors for the first time in the sense that that of its neighbors for the first time in the sense that loans were destined primarily to cover the capital and loans were destined primarily to cover the capital and operating costs of state-owned enterprises. operating costs of state-owned enterprises.

In 1986 the government was unable to make its In 1986 the government was unable to make its payments on a debt to Banco do Brasil; rescheduling payments on a debt to Banco do Brasil; rescheduling this debt blemished Paraguay's previously untarnished this debt blemished Paraguay's previously untarnished credit rating. credit rating.

In the late 1980s, Paraguay's national indebtedness In the late 1980s, Paraguay's national indebtedness grew.grew.

Paraguay’s EconomyParaguay’s Economy Paraguay has a market economy marked by a large Paraguay has a market economy marked by a large

informal sector. This sector features both reexport of informal sector. This sector features both reexport of imported consumer goods to neighboring countries, as imported consumer goods to neighboring countries, as well as the activities of thousands of micro enterprises well as the activities of thousands of micro enterprises and urban street vendors. and urban street vendors.

A large percentage of the population, especially in A large percentage of the population, especially in rural areas, derives its living from agricultural activity, rural areas, derives its living from agricultural activity, often on a subsistence basis. often on a subsistence basis.

On a per capita basis, real income has stagnated at On a per capita basis, real income has stagnated at 1980 levels. 1980 levels.

Economists attribute Paraguay's poor economic Economists attribute Paraguay's poor economic performance to political uncertainty, corruption, performance to political uncertainty, corruption, limited progress on structural reform, and deficient limited progress on structural reform, and deficient infrastructure. infrastructure.

The economy has rebounded between 2003 and 2007, The economy has rebounded between 2003 and 2007, posting modest growth each year. posting modest growth each year.

The 1980s were characterized by a crisis over The 1980s were characterized by a crisis over developing country debt.developing country debt.

The shift to contractionary policy by the U.S. The shift to contractionary policy by the U.S. led to:led to:

• The fall in industrial countries' aggregate demand. The fall in industrial countries' aggregate demand. • An immediate and spectacular rise in the interest An immediate and spectacular rise in the interest

burden debtor countries had to pay.burden debtor countries had to pay.• A sharp appreciation of the dollar.A sharp appreciation of the dollar.

• The Debt crisis began in August 1982 when The Debt crisis began in August 1982 when Mexico’s central bank could no longer pay Mexico’s central bank could no longer pay its $80 billion in foreign debt.its $80 billion in foreign debt.

By the end of 1986 more than 40 countries had By the end of 1986 more than 40 countries had encountered several external financial encountered several external financial problems.problems.

Conclusions for the 1980’s Debt Crisis

ConclusionsConclusions

The onset and aftermath of the debt crisis during the The onset and aftermath of the debt crisis during the so-called lost decade of the eighties led many so-called lost decade of the eighties led many countries in Latin America to abandon the inward-countries in Latin America to abandon the inward-oriented, state-led, ISI economic development oriented, state-led, ISI economic development model that had been in place for the better part of model that had been in place for the better part of four decades. four decades.

In its place was substituted an outward-oriented In its place was substituted an outward-oriented model heavily reliant on market forces. model heavily reliant on market forces.

Almost two decades latter the picture is mixed. Almost two decades latter the picture is mixed. Economic growth did not pick up as expected Economic growth did not pick up as expected during the nineties, leading to some during the nineties, leading to some disappointment in some countries with market disappointment in some countries with market oriented reforms. oriented reforms.

ReferencesReferences

Díaz-Bautista, Alejandro (2003), Los Determinantes del Crecimiento: Convergencia, Díaz-Bautista, Alejandro (2003), Los Determinantes del Crecimiento: Convergencia, Instituciones y Comercio Internacional, México, Editorial Plaza y Valdes.Instituciones y Comercio Internacional, México, Editorial Plaza y Valdes.

Edwards, Sebastian (1995) Crisis and Reform in Latin America: From Despair to Hope, Edwards, Sebastian (1995) Crisis and Reform in Latin America: From Despair to Hope, New York, Oxford University Press, pp. 15-40 (Chapter 2)New York, Oxford University Press, pp. 15-40 (Chapter 2)

Sachs, Jeffrey D. (1985) External Debt and Macroeconomic Performance in LatinSachs, Jeffrey D. (1985) External Debt and Macroeconomic Performance in LatinAmerica and East Asia, in Brookings Paper on Economic Activity No. 2. pp.523-573America and East Asia, in Brookings Paper on Economic Activity No. 2. pp.523-573

Sachs, Jeffrey, Aaron Tornell, and Andres Velasco (1996) The Collapse of the Mexican Sachs, Jeffrey, Aaron Tornell, and Andres Velasco (1996) The Collapse of the Mexican Peso: What have we Learned? Economic Policy (April) pp.15-63.Peso: What have we Learned? Economic Policy (April) pp.15-63.

Time Magazine. Time Magazine. http://www.time.comhttp://www.time.com

The IMFThe IMF The International Monetary Fund (IMF) was The International Monetary Fund (IMF) was

created in 1944, with a goal to stabilize exchange created in 1944, with a goal to stabilize exchange rates and supervise the reconstruction of the rates and supervise the reconstruction of the world's international payment system. Countries world's international payment system. Countries contributed to a pool which could be borrowed contributed to a pool which could be borrowed from, on a temporary basis, by countries with from, on a temporary basis, by countries with payment imbalances. payment imbalances.

The IMF describes itself as an organization of 185 The IMF describes itself as an organization of 185 countries, working to foster global monetary countries, working to foster global monetary cooperation, secure financial stability, facilitate cooperation, secure financial stability, facilitate international trade, promote high employment international trade, promote high employment and sustainable economic growth, and reduce and sustainable economic growth, and reduce poverty.poverty.

The Balance of Payments (BOP)The Balance of Payments (BOP)

In economics, the BOP measures the In economics, the BOP measures the payments that flow between any individual payments that flow between any individual country and all other countries. It is used country and all other countries. It is used to summarize all international economic to summarize all international economic transactions for that country during a transactions for that country during a specific time period, usually a year. The specific time period, usually a year. The BOP is determined by the country's BOP is determined by the country's exports and imports of goods, services, exports and imports of goods, services, and financial capital, as well as financial and financial capital, as well as financial transfers. transfers.

What led to the debt crisis of theWhat led to the debt crisis of the1980’s in Brazil?1980’s in Brazil?

Oil shocks of the 1970’s doubled the price of Oil shocks of the 1970’s doubled the price of imported oil into Brazil.imported oil into Brazil.

Political red tape preventing reforms to bring Political red tape preventing reforms to bring inflation under control.inflation under control.

Uncertainties regarding the future of the Uncertainties regarding the future of the economy increased economy increased world interestworld interest rates raising rates raising as high as 14.08% by 1981.as high as 14.08% by 1981.

• Excessive and unnecessary borrowing to maintain a high growth strategy by state enterprises.

• Overvalued Brazilian currency led to reduced exports.

• Bankruptcy laws preventing state enterprises from going bankrupt which transferred the burden of debt to the government.

What led to the debt crisis of the1980’s in Brazil?

What were the economic impacts caused by the What were the economic impacts caused by the debt crisis during the 1980’s in Brazil?debt crisis during the 1980’s in Brazil?

Increase in public debt and high interest rates led to Increase in public debt and high interest rates led to major economic problems for Brazil such as a major economic problems for Brazil such as a bankrupt public sector with accelerating inflation of bankrupt public sector with accelerating inflation of 1800% by the end of the 1980’s.1800% by the end of the 1980’s.

Negative Gross domestic product GDP growth. Negative Gross domestic product GDP growth.

Unemployment increased more than 6% during Unemployment increased more than 6% during Brazil’s 1981-1983 deep recession before moving the Brazil’s 1981-1983 deep recession before moving the economy back to full employment at 3.6% by 1986.economy back to full employment at 3.6% by 1986.

• Appreciation of the Brazilian currency during the beginning of the 1980’s against the US dollar that led to a recorded surplus with their trading partners.

• Reduction in inflow of direct foreign investment led to negative foreign savings as Brazil became a debtor nation with its current account raising to 16.3 billion.

What were the economic impacts caused by thedebt crisis during the 1980’s in Brazil?

Brazil Current accounts (in billions of US dollars) 1980-1995

-18.1

-1.20.2

6.1

-1.5-3.8

1.04.2

-1.4-5.3

-0.20.1

-6.8

-16.3

-11.7-12.8

-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Source: Boletim de Banco Centro de Brasil, FUNCEX, International Financial Statistics (IMF) (Graph 2).

Cur

rent

Acc

out

Brazil’s Negative Current Account Balance During the 1980’s

The current account of the balance of payments is the sum of the balance of trade (exports minus imports of goods and services), net factor incomes (such as interest and dividends) and net transfer payments (such as foreign aid).

How did Brazil solve the Debt crisis of the How did Brazil solve the Debt crisis of the 1980’s?1980’s?

Economic reforms were introduced in the Economic reforms were introduced in the 1980’s and 1990’s that included price freezes, 1980’s and 1990’s that included price freezes, readjustments and freezes on wages, rents readjustments and freezes on wages, rents and mortgages, and a fixing the exchange rate and mortgages, and a fixing the exchange rate to 1 real per US dollar. The plan’s objective to 1 real per US dollar. The plan’s objective was to eliminate inflation.was to eliminate inflation.

Other reforms included removing restrictions Other reforms included removing restrictions on free enterprise, foreign trade, increasing on free enterprise, foreign trade, increasing competition, privatizing public enterprises, and competition, privatizing public enterprises, and improving efficiency of goods and services by improving efficiency of goods and services by state-owned enterprises.state-owned enterprises.

How did Brazil solve the Debt crisis of the 1980’s?

• Enacted reforms required by the International Monetary Fund (IMF) agreements included: Tax and Pension reforms, changes working laws, Bankruptcy

law, and Independence of the Central Bank.

• However, few of these programs succeeded in Brazil because of its political instability and corruption. This Led to two decades of low economic growth and increases of social problems. Economic growth was low because of very high government deficits leading to inflation and the devaluation of the real during the 1980’s and 1990’s.

Economic Policy in Latin AmericaEconomic Policy in Latin AmericaIRGN 409IRGN 409

April-June, 2008April-June, 2008

The Debt Crisis in Latin America The Debt Crisis in Latin America

Alejandro Díaz-Bautista, Alejandro Díaz-Bautista, Ph.D.Ph.D.

[email protected]@gmail.com

Professor of Economics and Researcher at COLEFVisiting Research Fellow and Guest Scholar 2008, Center for U.S.-Mexican Studies, University of California San Diego (UCSD). April 2, 2008Graduate School of International Relations & Pacific Studies IR/PS University of California, San Diego