Why was the Washington consensus irresistible in Latin America - Essay Example

?Why the Washington Consensus Was Irresistible in Latin America Inserts His/Her Grade (18 December Outline Outline 2 Introduction 3 Why the consensus was irresistible to Latin America 3 Loss making in state enterprises 3 Distortion of allocation of resources 5 ISI programs 6 Low foreign investment 7 The debt crisis 9 The role of the IMF and Bretton Woods Institutions 11 Effects of globalisation 16 Conclusion 17 References 19 Why the Washington Consensus Was Irresistible in Latin America Introduction The Washington consensus was a series of neoliberal policies that arose from the US and diffused across several developing nations including Latin American ones. It came about as a result of a wave of globalisation. A number of historical occurrences had also led to the prevailing situation. This paper will trace the evolution of policy in the Latin American region in the decades prior to the consensus and during its actual adoption. The analysis will demonstrate how international banks as well as official financial institutions, politics, economic fundamentals as well as prevailing ideologies shaped the diffusion of neoliberalism in the region. Why the consensus was irresistible to Latin America The Washington Consensus took shape in the early 1990s starting with Mexico and Chile. Colombia, Argentina, Brazil, Guatemala, Peru, Venezuela and Bolivia would all follow suit. Fiscal adjustment was a key component of neoliberalism in this Consensus. Several countries removed fiscal deficits through changes in subsidy and taxation policies. Government was to step aside and let the market allocate resources on its own. Additionally, privatisation was also a crucial part of the reforms. Latin American governments were known for their heavy handedness in controlling their economies but these were privatised. Loss making in state enterprises As mentioned, Latin American governments had played a dominant role in the ownership of state enterprises. However, by the 1970s and 80s, it became evident that these enterprises were no longer making money (Gwynne, 2004). Creditors to the Latin American nations made them realise the benefit of privatising those institutions in order to make them profitable again. Since the US was one of the key lenders to Latin American countries, it soon became inevitable for these nations to privatise their institutions in order to boost the efficiency of their economies. Between 1980 and 1983, Latin America suffered from the problem of domestic debt. At the time, the countries had debt obligations to financial institutions outside the region. They were advised by the IMF to either increase their exports or minimise expenditure. Since these nations had a poor exporting history, many of them chose the easier option of curbing imports in their countries. This was sufficient to create a trade surplus of about $ 242.9 billion by the end of the year (Green, 2003). However, debts owed were almost close to these figures as they stood at $218.6 billion by the end of the decade. External debt as a percentage of GDP Source: Federal Reserve Bank of Atlanta, 2009. Imbalances of Latin American fiscal accounts. [online] Available at http://www.frbatlanta.org/pubs/econsouth/imbalances_in_latin_american_fiscal_accounts_whyunited_states_should_care.cfm Accessed 18 December 2013] The graph illustrates the precarious situation in which Latin America found itself in the late 1980s. Its debts had reached unsustainable levels. In order to meet these obligations, Latin American economies somehow had to find a way of converting their trade surplus into dollars. However, because most state-owned institutions were not generating positive rates of return, it was necessary to create avenues of accessing earnings from the private sector. These governments somehow managed to convince private investors to purchase government bonds in exchange for their currencies. Countries like Mexico and Brazil used very high interest rates to achieve these outcomes (Williamson, 1990). Essentially, the strategy had the effect of creating even more domestic debt that sometimes rivalled foreign debt. As if the latter situation was not enough, some Latin countries were not able to gather sufficient currency to meet their debt obligations. Therefore, some of them opted to use the printing press to deal with this challenge. In other words, they printed money. The overall effect was extremely high inflation rates. Estimates indicate that by 1989, Argentina had an inflation rate of 434% while Brazil suffered from an inflation rate of about 131% (Griffith-Jones, 1996). These problems would have been avoided if the concerned countries had well managed state corporations that would generate the vast majority of revenue needed to finance debt obligation. Because of this state of affairs, the Washington consensus would be the avenue needed to reverse this deteriorating cycle of fiscal problems. Distortion of allocation of resources Several countries in the region often controlled prices. Sometimes this would affect industrial products, utilities and even basic commodities. Their intention was to minimise inflationary pressures as well as distribute incomes. However, the strategy appeared not be working because it would require governments to subsidise several industries. As a result many sectors were making losses and this discouraged further investment (Baer and Maloney, 1997). The Washington Consensus provided a solution by requiring countries to free up prices and let them do their own adjustments. Alternatively, governments had the option of adjusting prices again so as to allow companies in the various sectors to enjoy a positive rate of return. The requirement made sense to Latin governments and would become a key component of policy changes (Edwards, 1995). This distortion also came in the form of the control of interest rates. By involving themselves so deeply in the financial sector, Latin American countries were trapped in a cycle of low savings. Resources could not be allocated efficiently because banks were forced to hold government debt, and had to contend with allocative quotas when giving loans. The end result of these measures was distortion of capital resources, which were scarce to begin with. It would thus be appealing for these nations to go with recommendations made Washington concerning the management of the financial sector (Krueger, 1998). ISI programs Import substituting industrialisation (ISI) had reached a plateau in the 1950s. Only Chile, Uruguay and Argentina were the countries that continued with economic reforms in the subsequent decade; the rest of Latin America was now contending with the problems of this model (Bulmer-Thomas, 2006). The model had become outmoded by several events so it came to a tumultuous halt in the region. Problems became evident in the 1980s concerning the high level of protectionism that the ISI programs created (Stallings, 1992). Although these programs were no longer in place, many of the characteristics that had been part of the ISIs were still prevalent in Latin America. For instance, protectionism was a key problem for these nations. They still used tariffs and quotas to shield a number of industries. As a result, competition was a far-fetched goal in several industries. Rent seeking was out of control and industries were not growing at the rate that they were supposed to. The Washington Consensus would prove useful to these nations because it would allow them to curb this rent seeking behaviour effectively (Bulmer-Thomas, 1996). Low foreign investment Latin American nations needed foreign investment in order to cope with the diminished fiscal resources that emanated from their debt crisis. Their technology was outdated and their industries were making losses. Private investment was at an all time low. These nations needed to look outside their borders for recovery (Fourcade-Gourinchas and Babb, 2002). Therefore, the Washington consensus was a rational choice because it gave them the tools with which they could provide incentives to foreign investors and thus get out of their financial woes. The Economist, 2003. Latin America: Wanted, a new regional economic growth agenda. [online] Available at: http://www.economist.com/node/1735514 [Accessed 18 December 2013]. The graph illustrates how capital inflows had reached a screeching halt in the late eighties just prior to adoption of the Washington consensus. Banks were searching for new business in developing nations because of liquidity problems in the 1970s. Latin American nations appeared to fit the bill because their financial markets were shallow enough to absorb incoming capital flows (Thorp, 1998). It was thus quite sensible for these nations to consider the Washington consensus because it would be the means for revamping those capital inflows that would dissipate the debt crisis. Green (2003) states that a capital flight of enormous proportion plagued nations in Latin America. Estimates indicate that by 1983, a much as $12.1 billion was leaving these economies and going to safer locations like New York or Zurich. Anxious investors converted their wealth into dollars so that they could protect themselves against potential drawbacks in the region. In fact, wealth transfer was now occurring in reverse. Capital was now being exported from Latin America to first world nations. A flow of approximately $218.6 billion occurred in the decade prior to the Washington consensus. The graph below shows the extent of trade in the region Extent of trade in Latin America Total capital inflows into Latin American between 1976 and 1996 Source: Edwards, S., 1995. Crisis and Reform in Latin America: From Despair to Hope. Washington, DC: World Bank Publications. Capital inflows had reached deplorable levels between 1982 and 1990 as seen in the figure above. The debt crisis Perhaps the debt crisis would be the biggest push for these countries to embrace the Washington consensus. Several of them now found themselves in a situation where their export sector was not sufficient to pay for their debts. These nations suffered from a stagnant gross domestic product (Cardoso and Helwege, 1992. Latin American countries had a debt crisis owing to adjustment programs that they were obligated to in the 1980s. Their creditors had instated the program in order to ascertain that they did not default on payment. While they were successful in achieving this, they also caused infrastructure weakening as well minimised social spending. In 1982, Mexico announced that it was unable to meet its debt obligations. This announcement took many by surprise as they had assumed that the country was strong enough to meet its external obligations. The United States was sent into panic mode because if Mexico continued in this state, the US would lose approximately $16.5 billion (Green, 2003). The latter figure accounted for about half of the capital in its banks. IMF stakeholders meeting in Washington also expressed their concern as several of them believed that other debtors would join. This would be disastrous to the international institutions because it would cause the very problems that Bretton Woods’s architects wanted to prevent. Mexico had tried many tactics to prevent this situation, such as increasing its restrictions on imports; its efforts bore no fruit. Imports thus fell, but this also affected exports as they also diminished. The overall trade surplus was thus too minute to meets its debt obligations and a negative resource transfer existed in the country (Balmer-Thomas, 2003). Mexico and several other Latin countries could not control those debts owing to external conditions that were beyond their control. At the time, these nations had to deal with rising oil prices that perpetuated increases in interest rates. This meant that external debts, which were valued at $234 billion in 1980, had increased by $118 in 3 years (Green, 2003). Such countries were overwhelmed by these situations and could no longer service their debt. It should be noted that these countries were finding it difficult to adjust because a growing economy was something that they were used to. Foreign capital inflows that were part of their economy came to an end after the 1970s. The crash that took place in 1982 meant that banks were no longer interested in lending to Mexico or its Latin counterparts. Latin American debt in billions of US dollars Source: Bulmer-Thomas, V., 2006. Globalization and the New Economic Model in Latin America. In: V. Bulmer-Thomas, J. Coatsworth and R. Cortes Conde, eds. 2006. The Cambridge Economic History of Latin America, Volume 2: The Long Twentieth Century. Cambridge: Cambridge University Press. Ch. 4. The decade 80 saw an exponential increase in debt within Latin America. While the figures rose even in the early 90s, ability to pay improved after the Consensus. Latin America seemed like a hopeless case to several investors. Investments never grew past $180 billion between 1984 and 1987. It seemed that no matter what the country did, it would never be sufficient to deal with the overwhelming debt. Therefore even though approximately $ 30 billion was leaving the region annually, their commitments were about $400 billion. It would be almost impossible for these governments to ever keep up. Furthermore, they neglected their domestic needs at the expense of these obligations. Infrastructure was appalling while electricity and drinking water, were at best sporadic (Green, 2003). The US was at the forefront of arrangements designed to assist Latin America in recovering from the debt crisis. It created two key plans to this effect. The first was known as the Baker Plan and was created in 1985. The Plan acknowledged that resources in the scheme were insufficient. It also argued for provisions to allow creditors to write off loans against taxes. Brazil was among the first to benefit from this provision. The Brady Plan would follow soon thereafter and was instated in 1989. Banks that had lent to Latin America were permitted to exchange their debts for loans and thus shield themselves from the crisis in this region. The banks used adjustment stabilisation conditions propagated by the IMF to end their relationship with Latin America. A number of them now exchanged the debt for treasury bills. It would later become evident that the Baker and the Brady Plan were insufficient to end the debt crisis because they only exchanged well known bank loans for anonymous bond handlers. This meant that the problem was still intact in the region (Bulmer-Thomas, 2006). The role of the IMF and Bretton Woods Institutions The Bretton Woods institutions were created after the great depression. Architects of these bodies felt that the world economy needed to be shielded from devastating economic predicaments again. Therefore, they created institutions that would curb trade policies which prolonged and intensified the great depression (Krueger, 1998). These institutions were created in order to oversee exchange rate arrangements such that there would be alternative methods of finance for countries (Birdsall, 2003.) Such finances would be available to those who had balance of payment issues that had not emanated from fundamental disequilibrium. As mentioned in the previous section, Latin American countries had challenges with exchange rates as well as balance of payments. It would soon be relevant for them to correct these inefficiencies through input from international financial institutions. Krueger (1998) also adds that Bretton Woods institutions were created in order to facilitate investment in instances where capital flows were insufficient. This goal was also associated with the need to oversee trade relations among countries so as to foster an open trading system. The latter would allow for full employment in those countries. Latin American nations had found themselves in a situation where they no longer attracted capital inflows into the country. In order to benefit from multilateral trade, they needed to adopt principles propagated by these international financial institutions. It was a known fact that the IMF often endorsed pro-globalisation policies. At the time of the Washington consensus, it was assumed that several countries around the world could embrace neoliberalism using preset rules (Stiglitz, 2002). The Washington bureaucrats responsible for the Consensus worked alongside the IMF. They were all market fundamentalists who believed that the answer to several problems in developing nations would be the liberalisation of their markets. Together, these groups worked to push for such policies in Latin America. Eurodad, 2006. World and IMF conditionality: A development of injustice. [online] Available at: http://www.google.co.ke/url?sa=t&rct=j&q=&esrc=s&source=web&cd=3&cad=rja&ved=0CD8QFjAC&url=http%3A%2F%2Fwww.eurodad.org%2Fuploadedfiles%2Fwhats_new%2Freports%2Fcritical_conditions.pdf&ei=WUq9UrHSF8egtAbm7oBw&usg=AFQjCNHgbSZRvI3oLhMUWwWkA7_KGMm1Ew&sig2=jI8vUfDDdHR8ALtKORLFvg&bvm=bv.58187178,d.Yms [Accessed 18 December 2013] In comparison to other conditionality, privatisation and liberalisation is a top priority for the IMF. The 1990s were marked by a series of rapid changes in the policy orientation of the Latin countries. Stiglitz (2002) argues that the IMF was responsible for this approach because it ignored a key component of its resource allocation criteria; which is gradual reform. The sequencing with which this neoliberalism occurred was also affected by the IMF. This institution called for full throttle adoption of liberal policies without regard for the order with which these changes would take place. It should be noted that the above move ran contrary to policies at the IMF. The World Bank has established some mechanisms for the speed and sequencing of the reforms in the 1980s. It believed that trade liberalisation ought to occur at a gradual pace with assistance from foreign entities. The World Bank also asserted that for any liberalisation policy to work, it needs to account for unwanted consequences like unemployment. This means that countries ought to make deliberate efforts to minimise these outcomes. Countries suffering from high fiscal imbalances should deal with this problem at the onset of the liberalisation process. The World Banks also stated that regulatory and supervisory agencies need to be put in place in order to realise financial reform. Finally, the institution believed that a country’s capital account should only be liberalised once the whole agenda nears completion. It should also take place when the export sector has grown substantially. In the 1980s decade, most people believed in these fundamentals and supported them. A shift in the mindset of World Bank members occurred in the early 1990s. They no longer cared for aspects of sequencing and speed of liberalisation. Washington in particular led this move and believed in fast and quick reforms. Most of them claimed that if reforms occured quickly, then they would eliminate possible opposition to liberalisation. These proponents disregarded the economic arguments for sequencing and thus put adequate pressure on developing nations of the world to take on neoliberalism at a simultaneous and rapid pace. Latin American countries therefore adopted the Washington Consensus at the pace and timing suggested by the US. There would have been a problem if the World Bank had not changed its commitment towards its own policies. Some analysts claim that if the earlier sequencing principles had been adhered to, then the character of the Washington Conesus as evidenced in Latin America would have changed dramatically (Walton, 2004). Watkins (2002) notes that loan conditions attached to aid in developing countries propagated the neoliberal agenda. The IMF and World Bank believe that elimination of trade barriers in developed and developing countries has the potential to grow economies. It is for this reason that import liberalisation has become a crucial part of loan application in these leading world institutions. Since poor countries require more financial support or aid than rich ones, then they form the bulk of the applicants in the World Bank and IMF recipient pools (Baer, 1974). These countries are at the receiving end of the trade liberalisation agenda of the institution. Their need for immediate financial support from these world institutions forces them to adopt all recommendations made by the entity without consideration of some of the potential repercussions of their actions. This explains why Latin America had to open up its economy to the world. The Washington consensus stemmed from such thinking. The World Bank has conducted research on the benefits of rapid liberalisation. Therefore, countries that adopt such policy responses will use the World Bank as proof that their policies are theoretical valid. These groups argue that trade liberalisation will benefit all equitably. The Washington Consensus recommended the adoption of neoliberal policies. Latin American nations gladly accepted this model because they believed that it was backed by the research of a credible and international institution; that is, the World Bank (Weyland, 2004). The IMF also had a role to play in the financial predicaments of Latin American nations in the 1980s. At the time, the IMF advocated for the devaluation of the region’s trade programs. Countries were urged to minimise imports in order to foster a trade surplus. However this policy had the effect of increasing the price of imported goods. The international body was thus causing high inflation, which was already a problem as alluded to in earlier sections of the paper. The end result was a compounded fiscal problem in the region. All countries affected wanted to exit from their respective situations as fast as possible (Green, 2003). Stallings (1992) explains that when understanding the relationship of international debtors and recipient countries, it is necessary to look into the concept of leverage. Leverage in this context refers to the use of rewards or punishment to exert financial control over others. The approach works when creditors are consolidated, and speak with one voice. It also works when the recipient has few options for borrowing. Latin American countries used to enjoy only moderately restricted loans from private lending institutions. Most of them were concerned about converting their petrodollars into profit. International financial institutions like the IMF felt that these institutions’ efforts were stifling their agenda (Bello, 2000). Many banks refused to attach economic conditionality to their loans. However, after 1982, a number of the entities soon realised that they were susceptible to economic problems. Therefore, they joined forces with each other and the IMF. The IMF convinced them to attach these economic conditions to loan repayment. Therefore, Latin American countries were now obligated to creditors who propagated IMF-sponsored principles (Weller, 2010). Effects of globalisation The era of globalisation had taken shape in the North American continent as well as different parts of the world just prior to the adoption of the Washington consensus. The US and several other international monetary organisations, like the IMF, called for the attraction of transnational corporations in these countries (Gallagher, 2005). They argued that world economies and people would be brought together through these firms. Washington and the IMF have also shown countries how to market themselves as attractive investors. This sweep took Latin American countries by storm. Many of them were now convinced that their protectionist policies were obsolete. In order for them to revamp their economies, they needed to involve other countries in trade. It was believed that globalisation would be the means with which they could get new technologies, financial resources or markets. The benefits of globalisation have now been disputed by some experts (Watkins, 2002). However, at the beginning of the 1990s, these benefits were greatly exaggerated. Latin America could not resist the Washington Consensus because of the perceived benefits of globalisation. The nations did not think about potential profit repatriation that might occur or the tax avoidance that would later be adopted by these transnational firms (Robinson, 2008). A country like Mexico underestimated the effect of globalisation on its industries. It did not expect that free trade zones would soon become enclaves that were separate from the rest of the domestic economy (Klein, 2007). At this time, most of the Latin American countries thought only of the positive effects of the interventions. Globalisation euphoria occurred at a time when Latin America was trying to solve its own problems in the debt crisis. World trade was growing at intense levels and elites trained in Washington advocated for an opening up of the Latin market. It needed to participate in global capitalism just like the rest of the world. Therefore, it came as no surprise when the respective country decided to embrace neoliberalism (Bulmer-Thomas, 2006) Conclusion The Washington Consensus was irresistible to Latin America because of a series of external and internal dynamics. Many Latin American countries were facing fiscal challenges that seemed insurmountable. They needed a way out of this cycle and the neoliberal policies of the Consensus seemed to be the way forward. They had challenges with management of exchange rates, allocation of state resources, attraction of foreign investment, eliminating the negative effects of ISIs and extricating themselves from the debt crisis. Perhaps the latter problem had made them quite desperate, and would cause them to be open to the neoliberal school. External drivers of the Washington Consensus in Latin America revolved around the international finance institutions and the concept of globalisation. When the region was struggling with its debt crisis, a new phenomenon known as globalisation took over. Elites in the region wanted their countries to participate so they embraced the Consensus. Additionally, international financial institutions propagated neoliberal principles among developing nations. Their loan conditions often pegged on these ideas, so after consolidating Latin American lenders, many recipient nations had no choice but to adapt. The Consensus was thus a combination of external and internal factors that pushed Latin America into the neoliberal band wagon. References Baer, W., 1974. The World Bank Group and the Process of Socio-Economic Development in the Third World. World Development, 2(6), pp. 1-10. Baer, W. and Maloney, W., 1997. Neoliberalism and income distribution in Latin America. World Development, 25(3), pp. 311-327. Bakker, A., 1996. International Financial Institutions. Harlow: Longman. Bello, W., 2000. 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