Latin America's Underperformance

Sebastian Edwards

From Foreign Affairs, March/ April 1997

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Summary:  The peso crisis was a wake-up call for Latin America. Reformist political leaders realize their support will erode if the economies of the region do not turn around. But building robust economies requires deeper reforms, at a time when the people suffer from acute reform fatigue. For rapid growth with rising real wages, export growth must be higher and value added to exports increase. To foster these, Latin America must address long-neglected weaknesses with a next generation of reforms in education, infrastructure, banking, and the civil service.

Sebastian Edwards is Henry Ford II Professor of International Economics at UCLA?s Anderson Graduate School of Management and a research associate at the National Bureau of Economic Research.

THE SHORT FUSE OF REFORM

In the last few years Latin American economies have undergone a remarkable transformation. Nations that sneered at the market system and pursued protectionist policies have suddenly embraced structural reforms aimed at stabilizing their economies, deregulating business practices, and becoming integrated with the rest of the world. After the Mexican peso crisis of December 1994, many observers predicted this process would end or, in some nations, be reversed. Their prediction proved false. Perhaps surprisingly, the reform effort continues -- albeit at a different pace -- in most countries. Now it appears that the Mexican crisis was a wake-up call for the region. Most political leaders realize that the reform process must intensify in order to build truly robust economies.

It is unclear, however, whether more rapid reform will be politically feasible. After almost a decade of reform, the region has little to show in improved economic performance and social conditions. Poverty has not been reduced. Growth has been modest at best. In many countries wages have stagnated, and job creation has been sluggish. For many countries, the reining in of inflation has been one of the few commendable accomplishments.

Until recently the Latin American population had given remarkable support to the reform process, rewarding political leaders who tackled their countries' perennial economic problems. The reelection of President Carlos Saul Menem in Argentina and the election of President Fernando Henrique Cardoso in Brazil have been perhaps the best examples. It is doubtful, however, that this support will last without faster growth and higher wages. For how long will the population be willing to make sacrifices? Is it realistic to ask the public to continue to back politicians who request patience while they are unable to deliver improved economic conditions? An increasing number of people are disillusioned, and there is a slowly growing sense of reform skepticism. The support for Abdala Bucaram's anti-reform platform in his election as president of Ecuador, the declining approval ratings of President Cardoso and President Alberto Fujimori in Peru, the general discontent in Argentina, the rejection of the reform program in Mexico by PRI members of Congress, and the violent demonstrations in Paraguay reflect increasing disappointment with the reform process. These events have shown that the Chiapas rebellion in Mexico may not have been an isolated incident, but rather the first sign of deep and growing dissatisfaction in Latin America.

In democracies, the durability of market-oriented reforms depends on the extent to which voters support the reformist government. The public generally supports governments that deliver solid economic performance. But under some circumstances, voters will back reformist governments even if the economy underperforms. What is important to realize, however, is that such backing is likely to be temporary. If the economy does not undergo a turnaround, voters will desert a reformist incumbent.

This dynamic suggests that unless growth accelerates, real wages increase, and unemployment declines, political support for Latin American reformist governments will erode. The prospects for faster growth and higher real wages ...

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