Brazil: A ‘Test Case’ for Continuation of Free-market Reforms in Latin America

Many Latin American countries, after trying to beat back rampant inflation and ignite economic prosperity through the adoption of free-market principles promoted by Washington in the 1990s, have grown unhappy with the results. So have these nations decided to make an about face and return to the populist, leftist policies of the past? Or are leaders in the region still largely committed to democracy and market reforms, despite their disillusionment with the rate of change?

Wharton management professor Mauro F. Guillen is inclined to take the first view. His department colleague, Gerald A. McDermott, is more comfortable with the second. Other experts on Latin America offer opinions that span both camps, depending on the country in question. In the meantime, the future direction of Latin American economies will be charted, to a large extent, by the outcomes of some two dozen presidential contests and legislative elections scheduled from December 2005 through December 2006. Elections will be held in Mexico and Brazil, which boast the region’s two biggest economies, as well as in Bolivia, Chile, Colombia, Peru and a slew of Central American and Caribbean nations.

“In the 1990s, just about every country in the region introduced more liberal economic policies and opened up to trade,” says Guillen, a native of Spain whose research focuses on international management. “This started to unravel with Brazil devaluing its currency in 1999,” a move that had a significant impact throughout the region. “Countries went into recession from 1998 to 2002. When the U.S. went into recession in 2001, Mexico came under stress because of its reliance on the U.S. So these reforms worked for while, but then came the bad economic news” which made Latin American leaders question the effectiveness of reforms — collectively known as the “Washington consensus.”

At the same time, major Latin American leaders — Carlos Salinas de Gortari in Mexico, Carlos Menem in Argentina and Alberto Fujimori in Peru — became caught up in corruption scandals, which, by association, ended up tainting the economic reforms they championed, says Guillen. There was a popular backlash. Some people saw that the rich were getting richer, while they themselves were not as well off, and they identified the nascent market-oriented policies as the culprit. The countries that have reverted to the most populist policies are Argentina and Venezuela, according to Guillen. Others are Bolivia, Ecuador and Peru.

“Mexico, Brazil and Chile are holding out,” Guillen says. “But these other five are moving in the opposite direction. It’s a pity. Governments are introducing policies that emphasize short-term gains for certain sectors of the population at the expense of long-term prosperity. They are keeping some prices artificially low. They are also making it harder for foreign firms to operate and invest. They are not as confident that free trade is going to help them. They are moving away from the orthodoxy, taking back the steps they made during the 1990s to open up their economies.”

Dissatisfaction with Democracy

For his part, McDermott says Latin Americans have some valid reasons for thinking that reforms have not delivered the goods. He points to a recent poll by Latinobarometro Corp., a Santiago, Chile-based non-governmental organization that surveys 18,000 Latin Americans annually for their views on politics and economics. As reported in The Economist, the poll suggested that “only one in three Latin Americans is satisfied with the way their democracy works in practice.” On a more positive note, Latinobarometro also found that Latin American presidents largely remain popular, that political institutions are “less reviled” and that respondents are a bit more optimistic about their economic prospects than in previous years, according to the magazine.

“What that poll shows is, across the board, a disillusionment with the sort of lofty, unrealistic claims or expectations that were promoted in the 1990s in the name of economic reform,” states McDermott, who has advised governments in Latin America and Eastern Europe. “So what you see now is uncertainty about what to do. The figures show, in general, that people don’t want to go back to the old ways but still don’t know what it means to have privatization or democracy. They’re not happy with most privatizations. But they don’t want dictators. They don’t really know how to improve the management of their democracies to get results. I wouldn’t say there is a ‘return to populism.’ I think most economists and analysts use that phrase as a sort of jingoistic shorthand to say the Washington consensus isn’t going well.”

McDermott describes popular sentiment in Latin America today as reminiscent of the tension that citizens of Eastern Europe experienced in the early days of the post-Cold War era. “You would have revolutionaries get into power and declare some sort of macro-privatization reforms. Then, the next elections would come and the governments would get thrown out, like they did in Poland and Hungary. And what did you hear? ‘We’re going back to communism.’ But we didn’t see that. What we saw were changes in policy. So the rejection of misguided economic reform policies in Latin American countries in the 1990s doesn’t mean they are going back to [the socialist days of] the 1970s.”

Carol Graham, professor of public policy at the University of Maryland and a senior fellow at the Brookings Institution in Washington, D.C., says some Latin American countries have found more success in embracing free-market principles than others, in part because of their political structures and high level of commitment, and in part because of their practical skills in getting things done.

“It’s easier if you’re Chile and your institutions work than if you’re Ecuador or Bolivia,” Graham states. “The record to some extent reflects that. Brazil and Chile are doing well. If you look at Chile’s structures and economic policies, Chile is not one you would put on a list of countries going off the rails. Argentina had a big crisis. Peru’s economic policies are separate from politics and pretty sound.”

Reform as Scapegoat

According to Graham, the countries that are questioning the efficacy of market reforms are troubled by a variety of entrenched social and economic problems and often use the reforms as a scapegoat. Bolivia, for instance, launched some creative reforms in the 1990s but the reforms did not address the country’s underlying poverty. Bolivia’s government also incurred the wrath of citizens when it privatized the national water company. “Discontent emerged, focused on market reforms,” Graham says. “Privatization is a good whipping boy, but it could have been anything.”

Ecuador, she adds, “has a fragile political system with a lot of unresolved regional and ethnic rivalries among socioeconomic groups that don’t have a system to channel those debates in a productive way. So it’s easy to toss out the status quo. What’s the status quo? Commitment to free trade and market reforms.” As for Venezuela, she says, “they are floating on oil money,” and President Hugo Chavez can literally afford to revert to old-style populism and lash out at capitalism in general and the United States in particular.

Jeffrey J. Schott, a senior fellow at the Institute International for Economics (IIE) in Washington, D.C., who specializes in international trade policy and economic sanctions, says Brazil and Mexico have been less apt to revert to populism. Even President Luiz Inacio Lula da Silva, a longtime leftist who won election in Brazil as a man of the people, has maintained the centrist economic policy that was pursued in the previous administration, says Schott, resulting in solid annual growth of 4% to 5% in gross domestic product.

That Lula has been steadfast in adhering to market reforms “doesn’t surprise me at all because his senior advisers came to IIE even before the election and brainstormed on options they had to deal with economic problems they thought they were going to confront,” Schott says. “We were struck by how pragmatic they were, and committed to restoring solid economic growth on a sustained basis for a simple reason: If they didn’t do that, there wouldn’t be money in future years to fund the social programs they believe are so strongly needed for their society.”

Still, all has not gone well for Lula. His administration has been tarnished by corruption scandals and some Brazilians feel that market reforms have failed. “Brazil is 40% of Latin America’s economy,” says Wharton’s Guillen. “Lula has implemented standard economic policies but many of his reforms have stalled.”

In Guillen’s view, Brazil is the bellwether as to whether reforms will continue to be embraced in Latin America. “Brazil is the test case. If something happens in Brazil and there’s a change to more populist policies, then that will change the whole region. Lula faces a problem that besets all newly elected leaders. They raise high expectations. But it’s hard to deliver on large and complex promises like reducing poverty. Poverty in Latin America cannot be fixed in three or four years. You can lay the foundation for [solutions] but people are impatient and want things to get fixed quickly. That’s unrealistic. Lula was hyped as somebody born in a slum who made it all the way to the presidency. He was well liked but it’s been hard for him to deliver.”

Pros and Cons in Brazil

In a report written in April after a trip to South America, Jay Bryson, an economist with Wachovia Bank in Charlotte, N.C., noted that Brazil had begun to reap significant benefits from its orthodox economic policy. Real GDP rose 5.3% in 2004, the strongest growth rate in 10 years, and Brazil’s current account, which historically had shown a deficit, actually was in surplus in 2003. But Bryson also pointed out that inflation had not been completely subdued, prompting Brazil’s central bank to boost its target interest rate by 3.75 percentage points — to 19.5% — between summer 2004 and spring 2005. That target rate, coupled with an inflation rate of 7.5% last spring, as measured by the consumer price index, gave Brazil one of the highest real interest rates in the world. (On November 28, the central bank projected that Brazil’s inflation rate would be 5.6% for the year 2005.)

For its part, Mexico sees little benefit in turning its back on market reforms. “Mexico is becoming increasingly integrated in the North American economy,” according to Schott. “It does have a network of free-trade arrangements with partners in the south. It’s part of a broader economic strategy to become a distribution center and a production platform for serving North America and South America. And it’s tried to attract investment from North America and Europe where it has free-trade agreements.”

Guillen believes it is something of a “question mark” as to whether Mexico will continue to adhere to free-market policies, even though its president, Vicente Fox, was elected in 2000 as a pro-business candidate. “Fox himself is not interested in populism. But there will be an election in the summer of 2006 and the outcome is up for grabs …. Mexico is unlikely to become like Venezuela, Bolivia and Peru because it clearly needs free trade with the U.S. Mexico is just too close to the U.S. to be isolated from it.”

By all accounts, Chile is the Latin American nation most committed to sticking with reforms. “Chile is by far the most stable country in region, both politically and economically,” and “it has well-established institutions,” according to Guillen. “By Latin American standards, there is a strong consensus in Chile that the country has to avoid economic populism.”

Bryson says the most important step Chile took in the 1990s was to open up its economy on several fronts. “They ditched their policies of the 1970s and 1980s and allowed imports to come in and exports to flow out. They also have had a fairly stable macroeconomic policy over the last few years, a relatively independent central bank and they haven’t jacked up taxes. That’s given foreign investors confidence, so we have seen investors increase [their holdings in Chile].”

At the other end of the spectrum is Venezuela, where the flamboyant Chavez has made headlines in recent months, calling himself a “21st century socialist” and railing against President Bush. But experts say Chavez is an anomaly whose extremism may play well with Venezuelan voters but is not a harbinger of a lurch to the left throughout Latin America. In an election held on December 4, supporters of Chavez appeared to capture nearly all 167 seats in the national assembly after five anti-Chavez parties boycotted the election. Some 75% of eligible voters stayed away from the polls.

Missing Link: Good Governance

Latin America watchers say countries in the region have little to gain by rejecting reforms, even if progress is slow in changing the lives of ordinary citizens, many of them in extreme poverty. “There’s no other paradigm,” says Graham, adding: “You can’t get around the need for growth and you must have stable macroeconomic policies to do that. But to resolve inequality problems you have to reform institutions. The missing link is good governance.”

Wharton’s McDermott, who spends part of each year in Argentina, stresses that proponents of democratic and free-market principles, among them U.S. economists and politicians, make a mistake if they do not take into account the complexity of Latin American countries. Yes, there are certain orthodox components of reform — price stability, privatization, a commitment to GDP growth — that should be adopted by any country committed to economic improvement. But a one-size-fits-all approach will not work in Latin America.