Latin American political leaders must stop grasping at “silver bullet” economic policies unless they want to consign their countries to irrelevancy in the world economy, said a former finance minister of Peru, who spoke at Wharton’s Latin America Conference Nov. 15.
“There is a tendency to look for a magic solution to everything,” said Pedro Pablo Kuczynski. “In the 1960s, it was land reform. In the 1970s, it was gigantic borrowing to finance so-called strategic state enterprises. And in the 1990s, it was privatization [of state enterprises].”
Grand schemes haven’t worked, and Latin America’s economic growth continues to crawl. It was at 3% during the 1990s, he said. “Measure that against population growth of 1.7%, and we were inching along at 1.25%.”
Two big events dragged down the region’s economy in the past decade – the devaluation of the Mexican peso in 1995 and that of the Brazilian real in 1999. “Without those, you still would have had only 4% growth for the decade. And that was with record capital inflows.”
Kuczynski, an economist trained at Oxford and Princeton universities, was named Peru’s finance minister in 2001 by current president Alejandro Toledo. A favorite of Wall Street and a former investment banker, he lasted less than a year. Toledo asked for his resignation in July as part of a cabinet shakeup. Kuczynski had advocated fiscal austerity measures that were unpopular with many Peruvians.
Today, he is president and CEO of the Latin America Enterprise Fund, an investment company in Miami. Before his forays into Wall Street and government, Kuczynski worked for the World Bank and the International Monetary Fund. He has been a student of the region’s economy for more than 30 years and is the author of a well-known text on Latin America’s debt crisis.
Rather than devising grand plans, he said, Latin American policymakers ought to focus on mundane but essential tasks, such as tax collection. Without adequate tax revenues, governments in the region won’t be able to invest in things such as rural roads, electrification, and water and sewer systems on which future growth will depend. “To stand still, like some of these governments do, and not have 30% to 40% of the population covered with clean, running water is practically criminal.”
A place to start improving tax administration is the value-added tax, which is popular in Latin American, Kuczynski suggested. In Argentina, the rate is 21%, but the country ends up collecting only about a quarter of the tax revenue that it is due. Peru’s rate is 18%, and the country collects only about a third of its expected revenues. “My philosophy is that any sales tax or value-added tax that makes a huge difference in the price of a product is going to be hard to collect,” Kuczynski said. “The taxes have to be simplified and the rates have to be reduced.”
Even without tax reform, Latin American governments can take steps to get more revenue by thwarting evasion. In Peru, for example, “we forced the largest enterprises in the country to become tax collectors,” he said. “We would give them a month of VAT collections as float as long as they only dealt with suppliers who themselves had paid the tax. We put this in effect in May, and since then, collections have been growing by 18% a month.”
Peru hasn’t been able to make those kinds of gains with its income tax. Collections amount to only about 3% of its gross domestic product, compared with about 13% in the United States.
Latin American leaders also must stop blaming their economic problems on the U.S. government, Wall Street and international organizations such as the World Bank and the International Monetary Fund, Kuczynski said. Fiscal policies advanced by this group are known as the “Washington Consensus.” “There is a lot of gnashing of teeth today about the Washington Consensus. But we should refresh our minds on what it was. It was simply a reaction to the debt crisis and a return to basics.”
The Washington Consensus advised Latin American countries to balance their budgets, make education and healthcare among their top priorities, reduce regulation, privatize government enterprises and eliminate barriers to trade. Besides, Latin American policymakers have little room to criticize policies that they have never fully implemented, he said.
Consider the issue of privatization. Chile embraced it in the 1980s, and Argentina in the 1990s. Other countries have been less enthusiastic. But where it has been tried, generally in the utilities sector, “there is no doubt that the results were stunning – in terms of coverage, in terms of efficiency of service – compared with the situation that existed 10 years before.”
Latin America, according to Kuczynski, has made strides on free trade, too, but remains too protectionist. In November, for example, Colombia proposed that the countries in the Andean group – Colombia, Bolivia, Ecuador, Peru and Venezuela – adopt a 20% import tariff.
Rather than trying to thwart imports, Latin America ought to aggressively export commodities such as sugar and cotton, which it produces cheaply. “Look at Australia, New Zealand or Canada. These are countries that are in very sensitive commodities, and they have very high per-capita incomes.”
The area where Latin American governments have made the least progress is fiscal policy. “The biggest problem we have is bad macroeconomic management,” Kuczynski said. In Argentina and Brazil, public debt has doubled in the last five years. Mexico and Brazil devalued their currencies. And several countries have tried “odd exchange rate policies,” which have exacerbated their problems.
In an attempt to stem inflation, some countries have chosen a totally fixed exchange rate. That has led to overvalued currencies that could be maintained only through high interest rates, which constrained growth. Plus, with high rates, government debt costs rose, requiring more money to pay interest, which tended to slow the economy even more. “That’s what happened in Brazil in the last three or four years.”
Kuczynski concluded his talk with two cautionary pieces of advice. Latin American leaders, he said, shouldn’t think social and judicial reforms are going to aid their countries’ growth. “East Asian countries are way behind Latin America in things like freedom of the press and judicial systems. Yet they grow. What makes growth happen is investment, not justice. People don’t eat justice. Justice is a goal that we must pursue, but we mustn’t think that justice is what’s going to create growth.”
Likewise, policymakers should understand that they have a limited time in which to jumpstart their economies. They face a coming demographic problem – a graying population – that will overwhelm any attempt at economic tinkering. “Because of modern health standards, Latin America is growing old before it grows up,” Kuczynski said. “In 2030, the average Latin American country will have more old people, per capita, than the U.S. has today. When you reach the stage where 20% of your population is over 65, prospects for productivity-led growth recede.
“So the question is, can growth get going in the next 25 years? That’s the window. After that, it will be gone, and our countries will be condemned to being bit players on the world stage.”