EconSouth (Third Quarter 2000)


INTERNATIONAL FOCUS


International Focus

All Pain, No Gain?
Reform Fatigue and the Long-Term Outlook in Latin America

For the past decade, citizens in Latin American countries have been subjected to the difficult adjustments associated with reforms that have been implemented to improve economic and social conditions. In recent years, many people in the region have grown weary of reforms that have yet to fully deliver the promised benefits. How the region copes with continuing reforms is key to its long-term outlook.

Most economic analysis of Latin America tends to concentrate on evaluations of current conditions and the short-term outlook. For investors, business people and policymakers, a firm grasp on the near-term situation is essential but only part of the equation. A true understanding of issues that affect the region’s longer-term outlook is also important, and the future of economic and political reform is a key determinant of this long-term outlook.

Fatigued by reform
During the last three to four years, an increasing number of studies have reported growing frustration among Latin Americans with the lack of economic and social progress after a decade of economic and political reform. This condition, called “reform fatigue,” is defined as citizens’ weariness with the sacrifices required by economic reforms and disappointment with the lack of progress with political reform in their respective countries.

While economic reforms may increase opportunities and lead to greater economic efficiencies, the transition from a closed to an open economy also brings about increased risk. This increase in short-term risk, insecurity and dislocation is at the heart of reform fatigue.

Reform fatigue has made many citizens of the region skeptical and wary of future endeavors to restructure their economic and political systems. Simply put, these citizens feel there has been too much pain and not enough gain.

The 1990s have seen the region’s annual rate of growth improve from the debt-crisis inspired stagnation of the 1980s, but growth still remains below the level achieved in the 1960s and 1970s (see chart 1).

The fact that economic growth has been so modest is not the only factor causing reform fatigue. The economic reforms of the 1990s have promoted domestic-market competition but opened Latin American economies to foreign competition as well. These developments have ended the traditional protection that many industries had taken for granted.

In addition, administrative reform in many countries has led to a decline in public-sector jobs and a resulting dramatic rise in unemployment. For example, the unemployment rate in the early 1990s was roughly 7.5 percent in Argentina. After reforms throughout the 1990s, that rate has risen to 13 percent in 2000. During the same period, the unemployment rate has risen from just over 4 percent to 8 percent in Brazil and from 10 percent to 20 percent in Colombia.

Such economic insecurity explains much of the dissatisfaction with current reform efforts. Evidence that Latin Americans are dissatisfied can be found in a variety of research, including an opinion poll taken in early 2000 in most Latin American countries by Latinobarómetro, a survey group based in Chile. The poll shows that support for democratic government remains strong; 60 percent said that democracy was the preferred form of government. However, only 37 percent said they were pleased with the way democracy works in their country. The poll also found that roughly two out of three people surveyed have little or no trust in their politicians, political parties, congresses, police or judiciaries.

International Focus

On the economic side, most Latin Americans favor a market economy, but the majority believe their countries are in bad shape economically, beset by increased poverty, a worsening distribution of income, heightened crime and corruption, and untrustworthy public institutions. Sixty percent of the respondents said that earlier generations lived better than people do today and half think their children will not be better off in the future.

Many of the region’s prominent commentators also have discussed the lack of reform results. “Ordinary citizens are losing faith in democracy,” Peter Hakim, president of the Inter-American Dialogue, a Washington-based think tank, wrote in a recent Foreign Policy article. Another well-respected Latin Americanist, Sebastian Edwards of UCLA, has been writing on the issue of reform fatigue for several years. In 1997 he wrote in Foreign Affairs, “An increasing number of people are disillusioned, and there is a growing sense of reform skepticism.” Enrique Iglesias, president of the Inter-American Development Bank (IDB), said in a speech earlier this year, “For large masses of our population, life in 2000 is a bewildering contradiction. All around them, they observe the kaleidoscope of progress driven by technology that is changing daily, while they themselves struggle against economic deprivation.”

The economic realities that have led to the general dissatisfaction with current economic outcomes are highlighted in a new report by the IDB called Development Beyond Economics. The report found that Latin America ranks above only Africa in adherence to the rule of law and the prevalence of corruption and also ranks very low in the effectiveness of public administration. These institutional defects account for almost 60 percent of the income gap between Latin America and richer countries, the IDB estimates.

CHART 1
Latin American Real GDP Growth
Chart 1
Source: United Nations, International Monetary Fund, Organisation for Economic Cooperation and Development, Federal Reserve Bank of Atlanta


CHART 2
Latin American Inflation
Chart 2
Source: International Monetary Fund

Why has support for reform continued?
Many analysts thought that the Mexican peso crisis of 1994–95 would signal the end of support for reforms in that country. After all, the very policies that were at the core of Mexico’s economic reform agenda beginning in the late 1980s — namely, bank privatization, capital liberalization and a pegged foreign exchange rate — were cited as leading causes for the peso’s devaluation in 1994 and subsequent recession in 1995. Yet support for economic reform in Mexico continued.

In 1995, Argentina also suffered in part because of the rigid foreign exchange regime that links the Argentine peso to the dollar — yet Argentine reforms continued. Again in 1998 and 1999, when many Latin American countries felt the aftershocks of the Asian financial crisis, they stuck to the path of economic reform despite the fact that their openness made them vulnerable to international economic shocks. Time and time again, Latin American policymakers have remained on the reform track despite negative experiences in the 1990s.

Clearly, Latin policymakers would not be able to maintain reforms without the support of the majority of voters. Indeed, policymakers would not even be in office if the general population did not support economic and political reforms. But why have Latin American voters continued to elect and re-elect reform-minded candidates?

One of the main reasons for voters’ continued support is that reform has produced an undeniably positive development — lower inflation. Chart 2 shows just how far the region’s inflation rate has declined in the past decade. Sustainable low inflation aids economic stability — a rare condition in the region until the 1990s — by guaranteeing citizens that purchasing power will not be purloined by inflation. Stabilization has allowed households and businesses to make longer-term economic plans with greater confidence that investment returns will not be eroded by high rates of inflation.

For the poor, especially, who are typically the most negatively affected by high inflation, price stabilization has brought enormous benefits. Such a transformation serves to remind today’s policymakers of the importance of remaining vigilant against inflation. Policies and the politicians that have enabled economies to stabilize have continued to be rewarded at the polls.

The future of reforms
Overall support for economic reform has continued in Latin America despite the growing disappointment with its benefits. But as memories of the prereform era fade, the development of reform fatigue clearly highlights a growing dissatisfaction with the current state of economic affairs in Latin America.

That reform fatigue exists is not the most important point. What is important is what this condition augurs for the future of reform policies in the region. In the absence of improved near-term outcomes, reform fatigue implies that sooner or later people will move to change the current process of reform. The public’s reaction to this development will be the key to the long-term outlook for Latin America.

Some analysts assume that reform fatigue will cause a negative reaction — that a popular uprising will end the reform process in Latin America and turn back the clock by undoing established economic and/or political reforms. Outright rejection of reform is, of course, possible, but four other scenarios are much more likely to develop:

  • erosion, a condition in which reforms cease and previously enacted measures are reversed, piece by piece;
  • deceleration, in which reforms are implemented more slowly and, in the extreme case, stopped altogether;
  • continuation, in which reforms continue to be implemented at the current pace, with no long-term pickup or slowdown; and
  • acceleration, in which political and economic reforms are enacted and implemented more rapidly.

Determining where individual Latin countries stand in the reform process and whether they are poised to reject, erode, decelerate, continue or accelerate reform is difficult. This task is complicated because each country has unique challenges, histories, institutional legacies and political hurdles to confront.

International Focus

In some countries, support for economic reform has continued but with an understanding that the reforms themselves would be reformed. For example, in the 1999 Chilean and 1998 Brazilian presidential elections, the eventual winners — Ricardo Lagos in Chile and Fernando Henrique Cardoso in Brazil — gained support for their plans to soften the economic reform blows that many people had experienced up to that point. These leaders also made commitments to bring more benefits of economic reform to the poor. In Chile and Brazil, the understanding was that economic reform would continue but that further reforms would address the needs of those people most negatively affected by the reform process. Both countries are continuing the reform process today.

In other cases, demands for economic reform have meant an acceleration of political change. In Venezuela, for example, reforming the political structure, seen by many Venezuelans as the main reason the country remains poor despite its vast oil wealth, is key to the support for President Hugo Chávez. While Chávez receives broad-based support for his political reforms, his zeal to create a new political order has led some pundits to see his reforms as undemocratic because he appears to be concentrating power in the executive branch. In addition, economic reform — desperately needed in Venezuela — has been slow. In this case, the fact that economic and political reforms are supported does not necessarily mean they are being implemented. In Ecuador, the last two elected presidents have been thrown out of office in large part because their proposed economic and political reforms were seen as going too far.

In Peru, the recent re-election of President Alberto Fujimori has called into question the future of democracy in that country because the electoral process was seen by many as unfair. If President Fujimori fulfills his promise to deepen democracy in Peru, however, political reform there may accelerate. Should he balk, reform may well erode, and some analysts believe he may have to revert to more populist economic policies — which deliver short-term relief but at the expense of long-term stability — to maintain power.

The recent election of Vincente Fox as president of Mexico indicates the desire for further political reform there as his election is the first in over 70 years in which the ruling party has not won the presidency; the Institutional Revolutionary Party had held that office in Mexico since 1929. Fox has pledged to expand democracy and distribute the benefits of economic reform more equally. The reform process may well accelerate in Mexico.

Reform — the next generation
The key to alleviating or eliminating dissatisfaction with reform in Latin America is to deliver more tangible benefits. These benefits can be developed through “second-generation” economic and political reforms. Examples of second-generation reforms include pension and tax reform, development of property and minority shareholder rights, and judicial reforms.

Efficiency-enhancing reforms that translate into more reliable and better public services could also help alleviate reform fatigue. These efforts would include administrative reforms and improvements in the delivery of utilities and clean water, for example. Progress on improving education and income distribution is also essential.

It is difficult to imagine Latin America really succeeding in the so-called new economy when primary and secondary education is so lacking in many countries. From 1960 to 1990, Latin America showed the smallest improvement in increasing educational levels when compared to the world’s other developing regions. In 1960, the average person in the region received only 3.3 years of formal education; by 1990 the average had risen to only 5.4 years. This average is still well below the world’s advanced economies and the transition economies in Eastern Europe. Even the developing countries of Southeast Asia fared better.

Income disparity also stunts the region’s long-term outlook. Chart 3 plots the intersection of per capita gross domestic product (GDP) and the World Bank’s measurement of income inequality — the GINI coefficient. A GINI index of zero represents perfect equality while a reading of 100 implies perfect inequality — the higher the reading, the worse the situation in terms of equality. The chart shows that Latin America remains one of the world’s poorest regions in terms of per capita GDP and is among the worst in terms of income equality. Until these conditions improve, the region’s long-term outlook will remain handicapped.

CHART 3
Poverty and Income Inequality: International Comparisons
Chart 3
Source: The World Bank and Federal Reserve Bank of Atlanta

Second-generation reforms are more difficult to put into practice because they cut more deeply into the economic and political structure of a country and threaten vested interests. Some of these interests are very influential and will resist the erosion of their power and control. Nevertheless, changes need to be made if Latin America is to reap and distribute the full benefits of economic and political reform.

Deepening democratic systems of government — at the national and local levels — is also key to the long-term development of a country. Some studies have shown that there is no direct correlation between democracy and economic progress, suggesting that economic reforms can be implemented and their benefits realized in the absence of a democratic system of government. Such studies, however, miss the point that where economic prosperity is the goal, the freedom for all citizens to pursue and enjoy these benefits is essential.

Dealing with reform fatigue
Knowing the short-term outlook for Latin America is essential to investors, business people and policymakers, but having a clear sense of the long-term outlook for the region is just as important.

A key to developing a long-term outlook is determining the future of economic and political reform. At present, Latin America is experiencing reform fatigue and a degree of disillusionment with the reform process. How the region addresses this fatigue is therefore especially important. Accelerating or continuing economic and political reforms and implementing second-generation reforms is necessary for the region to develop fully. Decelerating, eroding or rejecting the reform process would stunt economic and social progress. Latin America’s long-term future depends heavily on how it responds to the challenge of reform fatigue.

This article was written by Michael Chriszt, director of the Atlanta Fed’s Latin America Research Group.

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