Mexico and the World
Vol. 3, No 1 (Winter 1998)
http://www.profmex.org/mexicoandtheworld/volume3/1winter98/achillesheel.html

Hemisfile, July/August 1997

Latin America: The Achilles’ Heel of Liberalism

by Sidney Weintraub

A wave of liberal orthodoxy (classical liberal, what is often called neoliberal, and what in the United States would be close to what is thought of as conservatism) swept through Latin America about 10 to 15 years ago and still dominates the region's d evelopment thinking. The inspiration for this came from many sources: the harsh reality made clear during the lost decade of the 1980s that the previous dominant model, import substitution, had run out of steam; the successful example of the Chicago boys in Chile; the good growth performance of the export-led development model in East Asia; and the educational indoctrination that the new generation of PhDs in economics received at leading US universities.

The main elements of this liberalism as practiced today are markets that are open behind modest tariff and nontariff barriers, export promotion in place of export pessimism, an active search for foreign direct investment rather than grudging tolerance, jettisoning the populism that equated budget deficits and loose money with political popularity, intolerance toward runaway inflation, and less government involvement in running businesses. The government's role in the liberal model is to run a predict able macroeconomic policy and not interfere in setting prices for most goods and services.

The liberal model destroyed many privileges that had endured for as long as 50 years and put others at great risk. The previous oligopolistic control of domestic markets became difficult when the market was opened. Sinecures in government-owned enter prises became less plentiful. Tight budgets weakened social programs and reduced the resources for subsidies to favored groups, particularly in urban centers. The cozy arrangements between banks and businesses that were possible when real interest rates were negative gave way to more market-dominated lending. It is no wonder that old vested interest were reluctant to give way to a new paradigm. However, the collapse of the old structure left no option other than change, and this was facilitated by the existence of dictatorial or authoritarian governments in two key countries: Chile and Mexico.

Even though most Latin American countries are in better economic shape today than they were 10 years ago, it has become evident that no model solves all problems. The Achilles' heel of the experiments in liberalism, with their great reliance on marke t economics, has been in the social sphere. Octavio Paz, who clearly is not an anti-market radical, reflects the view of many Latin American intellectuals when he states that while the market is a powerful mechanism, it is blind and simultaneously create s abundance and misery. In country after country during the past decade, the social problems have been staggering: growing income inequality; high unemployment; a diminishing safety net; and, as a result, fragility of political continuity. If proponents of liberalism cannot win elections, this would be fatal to continuity of their policies.

The social problems are evident in Argentina and Mexico, two of the leaders in adopting liberal policies. In Argentina, the elimination of runaway inflation, coupled at first with high rates of growth in Gross Domestic Product (GDP), transformed Presi dent Carlos Menem into a political hero, and the economics minister, Domingo Cavallo, into an economicwunderkind. Yet today, when low inflation is an accepted reality, Mr. Menem's popularity has plummeted into the teens and Mr. Cavallo is out of the government. Anti-government riots are taking place in many provinces. The reason is the persistence of high unemployment, in the 17 to 18 percent range, despite GDP growth of around 4.5 percent in 1996 and equally high on an annual basis thus far in 1997.

Labor unions achieved great power during the years that Juan Perón ran Argentina and they resist efforts to make the labor market more flexible. The logic of the liberal model requires a competitive labor market, just as it demands competition in the production and sale of goods and services, but labor reform is proving hard to achieve in the democratic context of Argentina. The interests in labor matters are deeply entrenched.

Mexico was second to Chile in Latin America in adopting the liberal model. The process began modestly after the debt crisis of August 1982 and accelerated during the sexenio (six-year term) of President Carlos Salinas de Gortari (end 1988 to e nd 1994). Miguel de la Madrid, who started the Mexican apertura when he assumed the presidency at the end of 1982, has stated that he did so because he had no option. President de la Madrid took Mexico into the General Agreement on Tariffs and Tr ade (GATT) in 1986, and Salinas later took Mexico into the North American Free Trade Agreement (Nafta) in 1994. Each tried to lock in the trade apertura.

Mexico's new development model started under the heavy handicap of an economic crash and the recovery was drawn out for four years, from 1982 to 1986, during which time real wages dropped by as much as 50 percent (based on the minimum wage). These eff ects were the aftershocks of the old model, but they took place while the liberal model was taking shape. This permitted opponents of liberalism to blame the new policies even though the economic problems were created earlier.

Then, in 1994-1995, Mexico experienced the collapse of the peso and of the economy. This was brought on by a number of policy decisions unrelated to the essence of the liberal model, namely, an overvalued exchange rate and excessive short-term borrowi ng by the government and private banks in dollars or dollar-indexed instruments. Capital flight followed when the financial markets realized the extent of the policy weaknesses

The end result is that real wages in Mexico are lower today than they were before the 1982 crisis. Income inequality is higher. Macroeconomic recovery was impressive in 1996, just one year after the crisis, but the social effects of the 1995 experien ce were traumatic. The Institutional Revolutionary Party (PRI) has lost its near-monopoly on political power. Legitimate democracy is on the rise in Mexico and, precisely for this reason, policy continuity in the economic sphere is uncertain.

Chile avoided much of the social downside. When the Concertación, the coalition of center-left parties, took over the government from Augusto Pinochet in 1990, it promised to continue the liberal economic policies it inherited — this was a revo lution in the thinking of the Christian Democratic and Socialist parties compared with their views of the pre-Pinochet years — but to alter social policies, particularly to ease the restrictions on labor unions. The two governments since that time, of Pa tricio Aylwin and Eduardo Frei, have kept these commitments. Chile has enjoyed consistently high GDP growth since then, in the 7 to 8 percent range annually. Income inequality remains high, but the level of poverty has been reduced sharply.

National situations vary throughout the region, but there are similarities in other countries. Brazil has begun to open its economy and for the first time in decades has seriously tackled its inflation problem, with considerable success thus far. The fiscal deficit is relatively high this year, projected at 5 percent of GDP, but correcting this is essentially an issue of political compromise rather than of government tolerance. The authorities in Brazil have been slower to privatize government-owned enterprises than in Chile, Argentina, or Mexico, but the overall direction in favor of a liberal model is there.

In Peru, President Alberto Fujimori has clearly discarded the discredited inflationary policies of Alán García, his predecessor. Mr. Fujimori's recent decline in popularity is attributable largely to his failure to attack the grinding soc ial issue of widespread poverty. In Bolivia, President Gonzalo Sanchez de Lozada is clearly a liberal, which is not surprising given his economics training at the University of Chicago, and his popularity has diminished because of the country's serious s ocial problems.

The main laggard country in its use of liberal policies is Venezuela, where President Rafael Caldera is a throwback to the economic thinking of the 1960s and 1970s. The results there have been disastrous, with neither economic nor social benefits. Li beralism has its social costs; what Venezuela shows is that the failure to adopt liberal policies can also have a high social cost, but without benefit to the economy as a whole.

Unhappiness over the social effects of liberal policies have not been confined to Latin America. The recent parliamentary election in France, which was won by the Socialist coalition, represented the electorate's disgust with the 12.8 percent unemploy ment rate and the fear that the costly social safety net would be pruned. The decisive victory of the Labor Party in Britain, despite the recent good economic performance under the Tories, was a reaction to what was seen as excessive social rigidity. Th e Canadian electoral outcome is more ambiguous because of the complex regionalism that exists, but even there the high unemployment in Canada, especially in the Maritime provinces, worked against the Liberals.

Latin America has become increasingly democratic and proponents of the liberal model are discovering that electorates are responding not just to macroeconomic performance, but to its social accompaniment as well. For many years, those who favor a li beral model have been riding high in Latin America. The critics of the model offered no alternative other than a return to the old import-substitution, populist, inflationary programs. However, a reaction is now setting in over the social costs of rigid liberalism and the seeds of change are floating in the air.

The probability is high that there will be a paradigm shift in coming years forced by the combination of increasing political democracy and the social failures of liberalism. The new synthesis will likely be an uneasy mixture of liberalism and greater attention to resolving social issues, especially unemployment.