Latin America the Morning After: Euphoric Perceptions, Fragile Realities

Moisés Naím

From Foreign Affairs, July/August 1995

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Summary:  When thinking about Latin America, despair can be as disorienting as optimism. In the early 1990s, economic euphoria reigned in Latin America. Then came Mexico. The current gloom--the Tequila effect--will also pass. The recent wave of reforms dealt swiftly with such problems as inflation, low exports, currency instability, capital flight, and the boosting of regional trade. But to ensure prosperity after the peso debacle, Latin America must address its underlying woes: poverty, low productivity, and chronically ineffectual civic institutions.

Moisés Naím is a Senior Associate at the Carnegie Endowment for International Peace and Chair of its Latin American programs. Formerly, he was Minister of Industry of Venezuela and Executive Director of the World Bank.

Bewildered by the bizarre turn of events in Mexico, novelist Gabriel García Márquez told his colleague Carlos Fuentes that they should throw their books into the sea. "We have been totally defeated by reality," said García Márquez.

If Latin American realities defeat novelists with the magical imagination of García Márquez, foreign investors and policymakers are much easier prey. In mid?1994, the Financial Times warned that, "For those that think of Latin America in terms of generals, jungles, and sackfuls of worthless currency, it may be a time to overhaul some myths. Things have changed. South America's soldiers have long since goose?stepped back to the barracks, their power usurped by squadrons of technocrats and battalions of economic miracle?makers." Less than six months later, however, the same newspaper informed its readers that "Mexico's currency crisis has dimmed expectations for economies throughout Latin America. The crisis and the border war which flared up in January between Peru and Ecuador have raised some fundamental questions in the minds of investors about the wisdom of investment in Latin America. Given the losses they have suffered, some may well retire from the region for good."

It is hard to imagine a more drastic and rapid change of perceptions. In the first half of the 1990s, Latin America exhibited signs of an impressive economic transformation. New economic policies eliminated many of the debilitating symptoms that had long crippled the region. While their effects varied among countries, the reforms often dealt swiftly and effectively with high inflation, stagnation, poor international creditworthiness, low exports, currency instability, and chronic capital flight. The adoption of these policies coincided with unique circumstances in international financial markets and led investors to respond enthusiastically to the new opportunities in Latin America. Ironically, however, the massive inflow of foreign money was a mixed blessing. It helped speed up reforms and defrayed their costs, but it also masked some of the deeper sources of Latin America's poor economic performance, lowered the urgency of dealing with them, and created new problems. The success in tackling inflation, the unprecedented growth in trade among neighboring countries, and the euphoria of foreign investors obscured the drag on the region's economic prospects created by high income disparities, low productivity, low international competitiveness, and--most important of all--ineffectual public institutions. Governments easily postponed giving attention to these structural problems; likewise, foreign investors gave them only passing notice. After all, governments could not deal with such woes effectively without first eradicating some of their most visible and debilitating symptoms. It is hard, for example, to increase savings or boost competitiveness in the midst of hyperinflation. It was easy, however, for foreign portfolio investors not to pay too much attention to underlying fundamentals. They operated with short time horizons and enjoyed extraordinary international mobility, which lowered the risks of investing before deeper structural changes were made. Nonetheless, while the reforms have yet to improve the core problems of the region significantly, they did accomplish a striking set of positive changes that, in the ...

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