The Effect of Free-Market Policies on Latin American Countries - Essay Example

 The Effect of "Free Market" Policies on Latin American Countries; A Brief Look into the Urban Myth of the Rise of Free Market Societies 1. Abstract The purpose of this project is to explore the effects of free market doctrine on Latin American developing countries. The project will aim to provide a closer look at the relationship between democracy, liberal views and the adoption of "free market" libertarianism economic policies. It will seek to provide some background to the historical context that has allowed "free market" policies to: a) dominate all but one of the Latin American countries, and b) create the axiom in most people's psyche that "free market" equals fairness and equality. The paper will review the specific policies proposed by the Chicago School of Economics, and the so called "Washington consensus" and their application in Latin America. We will also analyze the claims of authors like Naomi Klein, that economic forces are driving our world toward "disaster capitalism", and contrast them with the views of the economist Sebastian Edwards, which although still critical of some aspects of the effect of free market on developing countries is supportive of the overall free market reform process. Our paper will provide evidence that supports the view of free market bliss as an urban myth based on consequentalist libertarianism that may have its origins in universities and think tanks in the United States, but has been adopted, implemented, and fostered by Latin countries through their own misconceptions, and misplaced hopes and enthusiasm. Outline The paper will focus on providing some background to the free market theory and its origins. It will then provide relevant examples of Latin American countries and their experience with free market experiments. It will also compare conventional wisdom that links protectionism with limited financial performance, with a) the economic belle époque of Latin America that coincided with the highest tariff levels in Latin America history, and b) specific examples of Latin American countries that adopted modern free market policies. 2. Free Market Libertarianism; the theory. This section focuses on the theoretical claims and structure of Free Market policies as neoclassical school of thought. We will focus specially on the contributions to this topic by the Chicago school of economics, and the so called Washington Consensus. Both of these schools of thought have been hugely influential in Latin American market reforms. Our analysis will center on their views on neoclassical price theory analysis, free market libertarianism, and an uncanny aversion to mathematical formalism. We will argue that the results oriented rationale of "free market" policies, which often forego more meticulous general equilibrium reasoning, could have been a catalyst not only for the financial crisis we are now experiencing, but also the failure of free market policies in Latin American countries. 2.1 Chicago School of Economics. The Chicago School of Economics is, strictly speaking, the approach of the intellectual community based around the department of Economics of the University of Chicago. However, it has come to mean a type of Economics that is based around the concepts of neoclassical price theory, "free market" libertarianism, low taxation, and privatization. However, it differs from completely free market economics in that it supports a strong government regulated monetary policy. This School of thought had a strong influence in Latin American countries in the 50s and 60s as a contributor of free market policies. The Chicago School of Economics finds its origins in Keynesian economics. Keynesian economics is a macroeconomic theory created by John Keynes. Its main premises are that a mixed economy is preferable, but it must be controlled by the government, because according to Keynesian views the private sector if left unbridled can make decisions that create an inefficient economy. The Chicago School of Economics supported Keynesian economics and then challenged it on their own terms in favor of monetarism; this is the theory that states that money supply is the most significant factor on national input and price levels. The main figure behind monetarism and the most representative author of the Chicago School is Milton Friedman. His theory of monetarism has influenced the economic policies supported by the United States Federal Reserve, the International Monetary Fund, and the European Central Bank. According to this view monetary supply is the main tool governments should use to avert financial crisis. Friedman used his theory to explain the reasons behind the Great Depression. According to him, the Great Depression was an "ordinary crisis" that was accentuated by misguided policies that contracted the money supply. Milton Friedman highlighted the advantages of free market economics and discouraged government intervention. In his book Capitalism and Freedom, Friedman makes the case for economic freedom as a prerequisite of political freedom. His argument is that for real political and intellectual freedom to exist there must also be economic freedom first, where production is not controlled by the government. In Friedman (and the Chicago School's) opinion, the government should restrict its intervention in public life to enforcing the law, protecting property rights, creating anti-monopoly policies, and making sure there is a sufficient supply of money. This book has become a classic in economy theory, and has influenced the market reforms and financial interventions of many countries (Argentina, Chile, Ecuador, see examples below) since. It would be unfair to categorize Friedman, or the Chicago School with Economic anarchy. He was in favor of abolishing the Federal Reserve System, but he would have it replaced with a system that automatically kept the supply of money at a steady rate. He supported eliminating conscription, and viewed his role in making this happen as his greatest accomplishment. In conclusion the Chicago School of Economics advocates the creation of unfettered free markets with little government control, with the exception of a strong government defined monetary regime. Their position is strongly based on consequentialist libertarianism. This view states that political and economical liberty lead unavoidably to the best possible consequences, happiness and prosperity. I argue that it is this view, consequentialist libertarianism that has been at the heart of the "success" of free market implementation in Latin American countries. It is a very pleasing theory; it inextricably combines libertarian economic views with an axiom most of us accept blindly: liberty is intrinsically good, and makes us happier. By linking personal freedom with economic freedom it charges "free market" theories with the positive connotations we all associate with freedom. American economic colonialism may have played its part in encouraging the inception of free market theories in Latin American markets, but it was not a bitter pill forced down their collective throats, but one that was gladly, even greedily accepted. We will see some examples of this below. We will now look at another powerful school of thought that has been linked with the Chicago School (Palley T, 2008), the Washington Consensus, and that has also been extremely influential in Latin American markets. 2.2 The Washington Consensus. The Washington Consensus is used to refer to a set of economic policies that have been implemented in Latin America during the late 1980s and 1990s, influenced by the US during the Administration, and Washington based institutions like the International Monetary Fund and the World Bank. The basic tenets of the Consensus are deregulation, privatization, and trade liberalization. The consensus includes a set of recommendations for market reform that have been called "ten commandments" for market reform, which have been implemented, at least in part, in a large number of countries. These recommendations are: 1) Fiscal Policy discipline. This effectively means a balance in the taxation, spending, and borrowing of the country. 2) Investment in services that promote long term growth like education, health and infrastructure. 3) Tax reform. The consensus advocates for a broader tax base and the inclusion of moderate marginal tax rates. 4) Interest rates should be determined by the market. 5) Exchange rates must be competitive. 6) Liberalization of trade (i.e. Free trade policies), this is characterized by a liberalization of imports, elimination of licensing and the reduction of trade protection measures like tariffs, and quantitative restrictions. 7) Liberalization of foreign inward direct investment (FDI). This refers to the investment of a country in the areas of management, technology, joint ventures and know how into another. 8) Privatization of state owned enterprises. 9) Deregulation measures that regulate competition except in the case of those required on the grounds of safety, environmental and consumer protection. 10) Protection of property rights. This so called Consensus shares a lot of views with the Chicago School of Economics which has caused critics to link them both and tag the Washington Consensus as a mere international tool with which to goad other markets into submission. Both economic schools of thought share a common view on an issue we will be studying in some more detail below: trade protection measures like licensing and trade tariffs. In fact both have demonized protectionist mechanisms as inhibitors of economic progress. 2.3 Criticism of "Free Market" Reform Policies. Criticism against the Chicago School has been strong, especially during the current financial crisis. Its laissez faire (leave it alone) attitude towards industry and the deregulation initiatives of governments following this view has been blamed for the current financial crisis by personalities like Nobel laureate Paul Krugman that described the Chicago School economists as "the product of a Dark Age of macroeconomics in which hard-won knowledge has been forgotten" (Krugman, 2009). The Chicago School may have recently suffered intellectual collapse, but it was not always this way. At one time it was the one size fits all solution to the financial woes of developing countries. Authors like Naomi Klein have put forth the view of the Chicago School, and Friedman in particular, as a dark force working in the shadows "waiting for a major crisis, then selling off pieces of the state to private players while citizens were still reeling from the shock, then quickly making the "reforms" permanent" (The Shock Doctrine). One of the most quoted examples of the influence of Chicago School economics, and one analyzed in detail in Naomi Klein's book, the Shock Doctrine, is that of Chile. Friedman acted as an adviser to the Chilean dicatator, Augusto Pinochet. The violent coup of Pinochet created a state of shock of an already traumatized society that had been hit by hyperinflation. The advice provided by Friedman was to impose en masse reforms to the economy. These included all the favorites of the Chicago School brand of economics: tax cuts, free trade, privatization of public services, cuts to social spending, and deregulation. Such was the influence of Friedman and the Chicago School economic theories the takeover became known as the Chicago School revolution, due to the sheer number of Pinochet's economists that had studied under Friedman at the university of Chicago. According to Klein, although free-market policies have, and are implemented through democratic means, they are carried out in a piecemeal fashion tempered by public opinion. However "authoritarian conditions are required for the implementation of its true vision". The view of critics of the Chicago School and the Washington Consensus is that their policies were forced upon Latin American countries (and other world regions like Asia, and currently Iraq) by the influence of Chicago School economic theories, and the bullying of Washington based institutions like the International Money Fund and World Bank, which restrict their "investment" to the performance of countries in key market reform policies, with catastrophic effects on the region's economy. The rest of our paper will focus on analyzing the effect of "free market" policies supported by the Chicago School of Economics and the Washington Consensus on specific examples of Latin American countries that implemented them. 3. Argentina, and Chile; Examples of Latin American experiments in Free Market Reform. Our study into the reality of free market reform in Latin America will be based around two main examples: 1) Argentina and 2) Chile. First though, let us paint a broad picture of the economic context of Latin America. It is important to start with the fact that free market reform has been carried out in every country in Latin America and the Caribbean except Cuba. That is, of the 33 countries that make up the Latin American region only one has not adopted to at least some degree the free market reform we described in our previous section. That is an amazing degree of implementation of an economic theory in such a large region with such a high level of granularity, or variety. You would be hard pressed to find much in common with countries like Haiti and Chile, yet they have both implemented some type of free market reform. Another amazing fact is that all of these countries, with the exception again of Cuba, have democratic governments, albeit with different levels of proficiency and transparency, but democracies nonetheless. It must be also be said, that despite the economic and political upheavals that have hit the region, democracy has been a constant in the last 10 years. What can account for such a widespread implementation of a single market theory? Critics like Naomi Klein point towards a conspiracy controlled by far right economists that take advantage of political and natural crisis to implement shock economic reform on unsuspecting citizens. Other authors, like Sebastian Edwards prefer a more organic and home-grown explanation. In his books: The Economics and Political Transition to an Open Market Economy: Colombia (2001), and Capital Flows and the Emerging Economies (2000), Edwards argues that the Washington Consensus and the implementation of free market reform was not orchestrated from Washington, or the U.S, but from Latin America. According to Edwards, the scene for this massive implementation of free market reform was set by a shockingly miserable economic context characterized by hyperinflation, incredibly low levels of production and widespread corruption. Both Klein and Edwards share the view that a 'severe crisis' was the catalyst of free market reform, but they disagree on who was behind it. Edwards is of the opinion that the Latin American Free Market reform is a Latin product. In his opinion it all began with the application of market reform to Argentina, Mexico, and Chile, with other countries following suit as other political events like the fall of the Berlin Wall and the liberalization of the Spanish economy under Felipe Gonzalez, pushed public opinion towards free market ideology. In fact he argues that they implemented these free market reforms in such a violent and rapid fashion that the Washington based institutions that are supposed to have created the Washington Consensus actually opposed their methods. For instance the IMF strongly opposed the privatization of social security in Chile; the U.S Treasury did not support the currency board that tied the Argentinean Peso with the Dollar in a one to one exchange rate; and the World Bank was very nervous about Mexico's move towards a free trade agreement with the United States. These three instances are at least three examples of "free trade" reforms that did not have the backing (at least at first) of Washington and were the brainchild of Latin economists. What has been the effect of these market reforms on Latin American countries? It has been varied; some have done relatively well like Chile, while countries like Argentina are presented as graphic examples of its failures that have only been able to recover thanks to the application of protectionist and conservative policies. We will take a closer look at both of these extreme examples and see the effect free trade has had on their economies. 3.1 Chile The economy of Chile is based around agriculture, fishing, logging, and the exploitation of its main exports copper and nitrates. In the 19th century its economy grew on the back of its two main exports. This lasted until World War I when the nitrate market collapsed, harboring a downturn in the Chilean economy, which intensified the effects of the Great Depression. This economic atmosphere turned Chile to more socialistic programs, with strong government regulation of the economy. Resources were injected into subsidizing national industries, agrarian reforms were carried out, and the state took greater and greater control of the country's industry. This climate peaked under the administrations of Pedro Aquirre Cerda (1938-1941) and Salvador Allende Gossens (1970-1973), which saw the nationalization of banks, the all-important copper mines, and other key businesses. At first, these measures enjoyed some success. In fact the belle époque of the Latin American economy, Chile's included, coincides with the highest tariff levels in the region's history. This demystifies the concept that low import tariffs are required for economic growth to occur. However, a tax base to match the growing Chilean economy was not created and by 1973 the economy was deteriorating, and fast. In September 1973 Augusto Pinochet took over the government of Chile. By 1975 the so called Chicago boys, economists that had been trained under Milton Friedman took over the control of financial policy. As described above when referring to Naomi Klein's book The Shock Doctrine, dramatic changes in Chile's economy occurred in rapid bursts of market reform, and market forces were allowed to guide most of the economy's decisions. What Klein fails to mention in her book is that the reforms were a success, at least a qualified success; if one chooses to ignore the social injustices, torture and state terror carried out by the regime. Nevertheless, from a purely financial standpoint Chile's free market reforms worked beautifully: inflation was reduced, government deficit virtually disappeared, and a strong market system was created. However, that is only part of the story. Socially the results were not so great; the standard of living of the poor got worse, wages dropped and the gap between the rich and poor widened considerably. In 1981, a severe debt crisis hit the Chilean economy, and unemployment levels peaked at 20%. This triggered further reforms that focused on the growth and expansion of exports. These reforms caused a second recovery, and further shifts towards a free market economy. When Pinochet "gave up" power in 1990 to Patricio Aylwin, Chile had the best performing economy in Latin America; economists, analysts, stockbrokers and politicians wondered what changes the new government would make to the free market reforms carried out by the Pinochet dictatorship. The answer was none whatsoever. If anything free market reform increased, although a special effort was made to invest in social programs. This was very important in the spreading of free market theory to Latin American countries, after the continuation of market reform by Chile's democratic government country after country has started making their own market reforms. So has the consistent application of "free market" policies for over 30 years helped the Chilean economy? It all depends on how you measure success and failure. Chile is the 11th most free country in the 2009 index of Economic Freedom. The GDP growth of Chile has kept an average of 4.0% in the last five years and enjoyed a 6.1% growth in 2004. This data would support the view that free market policies have created what Milton Friedman called the "miracle of Chile". However, other economists like Amarya Sen, argue the complete opposite view. They point towards the fact that there was little economic growth during 1975-1983, the hardcore "Monetarist experiment" years, and that real growth only started once other reforms were applied. Probably, more importantly social indicators remain poor in Chile, but so do they, and to a greater degree in other Latin American countries. 3.2 Argentina Argentina is often described as a classic example of the failure of free market policies. As described in "An Economic History of 20th Century Latin America" pre-1930 Argentina was characterized by the staple theory of trade and growth. This was linked to ongoing growth in the export of land intensive commodities, while the opportunity cost of land remained very low. Argentina became the most prosperous country in Latin America. The Great Depression caused the growth trend that had characterized Argentina's economy to reverse drastically in the years from 1930 and the 1970s. This caused Argentina to fall from being one of the riches countries in the world to being part of the developing countries (a.k.a Third World). Successive protectionist measures were made by the governments in power from the 1930s to the 1970s. These measures centered on stimulating Argentina's industry, in order to attain industrial self-sufficiency. This was done by charging high tariffs on imports and subsidizing Argentina's textile, leather and appliances industry. These measures enjoyed some success, and seem to be at the heart of the Latin belle époque. By 1975 Argentina was practically self sufficient in steel, and vehicle production. The manufacturing industry was at this stage the single most important component of the country's GDP. However, the 1973 oil crisis triggered a severe financial crisis that caused the government to resort to sharp currency devaluations and wage controls. Hyperinflation, strikes, and violence paved the way for a violet military coup in 1976. This opened a period of Argentina's economy controlled by Cambridge and Chicago School trained economists that applied free market theory to the ailing economy. However, they were unable to curb military spending or avoid the scandalous levels of corruption, in which they often took an active role. These corrupt free market measures included a monetarist financial liberation that only increased the burden of national debt. The government then supported a strong peso policy that pushed inflation to over 100% a year that encouraged imports, and dampened national industrial production. President Carlos Menem administration commenced in 1989, with the economy in a critical state, inflation reaching 5000% a year. The President passed a number of free market policies that included trade liberalization, deregulation and privatization. At first, results were mixed, so he implemented even more radical policies. For instance he put into action monetary reforms that linked the U.S dollar and limited the monetary base of the country to the growth in reserves. The results of such policies seemed promising, inflation dropped to single digits in 1993, from 1300% in 1990. Privatizations provided a varied sample of successes and failures, but the structural reform did provide stability and a stop to runaway inflation. Foreign debt did rise, and so did unemployment. However, Argentina was still considered a model of the benefits free market reforms can reap in third world countries. Then, in 1999 came the Argentine economic crisis that made the whole pack of cards fall. Public debt continued to grow, and while the IMF was a willing lender, tax evasion, money laundering and other cases of corruption coupled with an increase in unemployment pulled the economy further down. Recovery did not begin until 2003, when President Nestor Kirchner came into power. Kirchner and his Minister of Economy, respected economist Roberto Lavagna, applied protectionist measures like import substitution, and subsidized credits for businesses. The recovery of Argentina, and its consistent GDP growth in the last 10 years has occurred with surprising strength. The distribution of income is far from equitable, but compares favorably with other Latin American countries. 3.3 The Lessons. The Latin American region is so complex it is hard to learn specific lessons from the analysis of just two examples, and even more detailed studies will struggle to find strong parallels between the economic past of such a varied, and heterogeneous region. However, we will deal with three of the criticisms presented against the implementation of free market reform in Latin American, as a benchmark to measure its effect on the region as a whole. The first criticism is that the performance of countries that have undergone free market policies has not been good. The fact is that the economic shape of Latin America is not good despite the claims that liberal policies would bring wealth and prosperity to the region. However, there have been two main successes, a reduction of inflation in most countries, and relatively sturdy democratic governments. Another line of defense open for the free market view is how uneven the application of free market reform has been in Latin America. Some countries, like Argentina privatized everything, but in a completely corrupt way, while others like Brazil and Mexico privatized very little. The sequence by which free market measures were carried out were also different from country to country. Most countries were only willing to accept some free market measures of the so called Washington Consensus, but not others. The big picture is that some countries have done relatively well, like Chile and Costa Rica, while others have suffered greatly like Argentina. However, the history of Argentina does show a habit of diving and rising from one crisis to another. There has already been a few cases of protectionist and liberal successes in Argentina's past and many are wondering when the next crisis will occur. The theory that these bubbles and crisis can be blamed entirely on the implementation of free market policies is very suspect. The second criticism is that the performance of such policies was oversold; it did not reduce corruption and promote transparency. In fact privatization created a new type of corruption with insiders taking advantage of their position. This is true in most cases. Mexico and Argentina being "excellent" examples of the levels of corruption that can be created when deregulation and privatization is carried out on an economy without the necessary checks and balances to offset extreme corruption. 4. Conclusion. Our study of the history of Latin American economies (based around that of two extreme cases, Chile and Argentina) has showed that it is very hard to press judgment on free market theories supported by the Chicago School of Economics and the Washington Consensus as a whole in Latin America because it elements were either applied in a piece-meal fashion or were not carried out consistently. However, our study does debunk the urban myth that links in the minds of many economists and consumers that free trade policy like low import tariffs are inextricably linked with prosperity and high tariffs create a morose economy isolated from the world. The belle époque of the Latin American economy occurred when import levels and protectionist measures like import substitution were at their highest. On the other hand our analysis of Chile's economy does seem to show that free market theory coupled with a generous supply of foreign investment can be linked with stability and a steady GDP growth. However, this view is contested by economists that link these positive traits with the implementation of other types of policy that were also implemented. Lower levels of inflation and stable democracies do seem to be a positive side effect of free trade policies. As a side point, the view of authors like Nicole Klein that the influence of right wing free market policies was a conspiracy theory designed to model Latin American economy to the wishes of United States does come across as a huge simplification of a trend that is extremely complex and dependant on each country's vision of free market policy. As shown above the over enthusiastic manner in which Argentina linked the peso to the dollar, Mexico signed a free trade agreement with the U.S., and Chile privatized health services was not supported by the exact institutions that were supposed to be encouraging these policies. Nevertheless the energy with which Chicago School economists have portrayed the consequentalist libertarianism view that economic freedom leads unavoidably to financial success can be seen as partially responsible for the excessive optimism and deregulation that has triggered the current financial crisis and oversold the benefits of free market policies. 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