Bulmer-Thomas V., Coatsworth J., Cortes-Conde R. The Cambridge Economic History of Latin America: Volume 2, The Long Twentieth Century

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142 Victor Bulmer-Thomas

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Figure 4.2.High income countries: gross private capital ﬂows (% of GDP), 1980–2000.

Source: World Bank,WorldDevelopment Indicators 2002.

of payments problems. The United States, for example, extended its restric-

tions on outﬂows of capital in the 1960s and the United Kingdom did the

same in the 1970s.

The Reagan–Thatcher revolution in the 1980s had many characteristics,

but one of the most striking was the bonﬁre of capital account and currency

restrictions. Ironically, this took place after the boom in bank lending to

Latin America that led to the debt crisis. Yet there can be no doubting the

qualitative change that took place in the scale of capital ﬂows in the mid-

1980s. Because high income countries are both exporters and importers of

capital, the best way to capture this change is by summing the inﬂows and

outﬂows of all private capital (direct, portfolio, and other) and normalizing

by expressing the result as a percentage of GDP.

The result is given in Figure 4.2, where the structural break in the mid-

1980s for the high income countries is immediately apparent. From a low

of 7.1 percent in 1985, the ratio had jumped to nearly 15 percent by 1995

and nearly 35 percent by 2000.For the countries making up the euro-zone,

perhaps themost integrated bloc in the world, the ratio had reached 32.2 per-

cent by the end of the twentieth century. By contrast, the ratio for low

income countries remained depressed throughout the period. It was 0.7 per-

cent in 1988 and only 2.0 percent a decade later. Most of these private gross

capital ﬂows went from developed countries to developed countries.

The acceleration in private capital ﬂows was not only attributable to

the lifting of restrictions on the capital account of the balance of pay-

ments. It was also caused by the new international division of labor and

the need for MNCs to expand their operations around the world. DFI,

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Globalization and the New Economic Model in Latin America 143

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Figure 4.3.High income countries: gross foreign direct investment (% of GDP), 1980–2000.

Source: World Bank,WorldDevelopment Indicators 2002.

also measured as the sum of outﬂows and inﬂows, shows a similar trend

(Figure 4.3), rising for high income countries from below 2 percent of GDP

in 1985 to 10 percent in 2000.Inthe United States, where the size of the

domestic economy reduces the relative importance of gross capital ﬂows,

gross DFI ﬂows represented almost half of all private capital ﬂows by the

end of the 1990s.

These DFI ﬂows increased in importance in all regions of the world after

the mid-1980s. In middle income countries, they quadrupled as a share of

GDP between 1988 and 1998,reaching 1.6 percent. In upper middle income

countries, theyrose even faster, to 2.2 percent. Even in low income countries,

they had risen to nearly 1 percent in 2001 from 0.2 a decade earlier.

country that was serious about meeting the challenge of globalization could

afford to ignore this trend, and governments all over the world reformed

their legislation on DFI in order to increase their chances of beneﬁting

from the increased mobility of capital.

Despite the growing importance of DFI, portfolio capital continued to

dominate gross capital ﬂows. Restrictions on the ﬁnancial sector were lifted

in advanced countries. Mergers and acquisitions within the ﬁnancial sectors

accelerated. Local institutions became regional and regional institutions

became global. New ﬁnancial instruments were pioneered and the bond

markets were especially dynamic. Developing countries were redeﬁned as

SeeWorld Bank, WorldDevelopment Indicators, 16 and 332.

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144 Victor Bulmer-Thomas

“emerging,” “pre-emerging,” or “frontier,” and pressure built up inside and

outside to make the equity markets more liquid and accessible.

The elimination of restrictions on capital movements in developed coun-

tries in the 1980s was followed by their elimination in developing countries

in the 1990s. The IMF and the World Bank put pressure on borrowing

countries to liberalize the capital account of the balance of payments. In

many cases this was premature,

as Southern Cone countries in Latin

America had discovered to their cost at the beginning of the 1980s. Yet

these lessons were not heeded and the speed of liberalization was one of the

main reasons for the ﬁnancial crisis that hit Asia in 1997.

The other reason for the Asian ﬁnancial crisis was the pegging of local

currencies to the dollar at a time when the dollar was exceptionally strong.

Unlike trade and capital account liberalization, there was no consensus

on exchange rate management and the debate has continued to rage in

favor of ﬁxed or ﬂoating currencies. However, globalization introduced

anew element into the debate because closer integration of trade and

factor markets raises the possibility of currency substitution. A number of

developing countries have therefore experimented with new exchange rate

arrangements ranging from currency boards (e.g., Hong Kong) to adoption

of foreign currencies (e.g., Montenegro).

Latin America’s efforts to exit from the debt crisis had to take these

new circumstances into account. The short-run need to adjust the external

sector to free up resources with which to service the foreign debt was over-

shadowed by the medium-term requirement of adapting to the challenge of

globalization. How this twin challenge was met is the subject of the second

part of this chapter.

THE LATIN AMERICAN RESPONSE

The need to save foreign exchange in order to meet the rising costs of debt

service led Latin American countries at ﬁrst to increase – not decrease –

the restrictions on imports. After the Mexican government threatened to

default in August 1982, tariffs were raised in many countries and nontariff

barriers (NTBs) increased sharply. In addition, output was falling as a result

The Asian ﬁnancial crisis in 1997 and subsequent ﬁnancial crises in other parts of the developing

world led to a reconsideration of the merits of capital account liberalization. For a severe critique,

see Joseph Stiglitz, Globalization and its Discontents (New York, 2002).

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Globalization and the New Economic Model in Latin America 145

of the decline in the terms of trade, the global recession, and the tightening

of ﬁscal policy.

Imports did indeed fall, but so did the value of exports. The resulting

small trade surplus was insufﬁcient to service the debt and Latin American

countries were dependent on inﬂows of capital from ofﬁcial sources coupled

with creative accounting by the international private creditors in order to

avoid falling into default. The net transfer of resources turned negative

because debt service payments far exceeded the net inﬂow of capital.

The United States, as might have been expected, took the lead in coor-

dinating the response of the creditors (private and ofﬁcial) to the Latin

American debt crisis. The ﬁrst public recognition that the position of the

debtors was unsustainable came in 1985 with the announcement of the Baker

Plan. Named after the U.S. Secretary of the Treasury at the time, the Baker

Plan identiﬁed the crisis as one of liquidity rather than solvency, but the

additional resources provided under the scheme were quite inadequate. By

February 1987,Brazil had declared a moratorium and international banks

rushed to declare their Latin American loans as value-impaired. This forced

them to make loan-loss provisions, but these were cushioned by permis-

sion from the ﬁscal authorities in their countries to write them off against

tax.

The Baker Plan was followed by the Brady Plan in 1989, named after

Nicholas Brady, who succeeded James Baker as U.S. Treasury Secretary.

This scheme was more radical in that it offered private creditors a menu

from which they could choose provided they had met the conditions for

adjustment stabilization agreed with the IMF. The most popular choice

was to exchange the nominal value of bank debt for bonds with a lower face

value with collateral provided by zero-coupon Treasury bills. These Brady

bonds, as they were immediately dubbed, allowed banks to exit from their

exposure to Latin America and therefore brought to an end the 1980s debt

crisis.

It did not, of course, end the problem of indebtedness. The debt now

took the form of bonds rather than bank loans, but the export sector in most

countries was still very small in relation to both the size of the economy

and the debt itself. Indeed, many commentators at the time argued that

the Brady Plan, like the Baker Plan, was too little and too late.

SeeVictor Bulmer-Thomas, The Economic History of Latin America since Independence, 2nd ed.

(Cambridge, 2003), ch. 11.

The net transfer of resources is deﬁned as net capital inﬂows less payments of interest and proﬁt

remittances.

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146 Victor Bulmer-Thomas

200

400

600

800

1000

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Figure 4.4. Latin American external debt, 1980–2000 (US$ billion).

Source: World Bank,WorldDevelopment Indicators 2002.

We shall never know whether the critics were right or wrong because

the Brady Plan was soon overtaken by events. For reasons discussed subse-

quently, the main Latin American countries were suddenly the beneﬁciary

of new capital inﬂows starting in 1990 that reversed the negative net transfer

of resources. Instead of foreign currency scarcity, there was foreign exchange

abundance. Some governments even issued new bonds in order to retire

the Brady bonds.

The result was a surge in external indebtedness just after the Brady Plan

was supposed to have ended the debt crisis (see Figure 4.4). The main

Latin American countries experienced a build-up of debt that was even

greater than in the period before 1982. This time, the creditors were largely

anonymous because they were bondholders rather than banks, making a

coordinated creditor response extremely difﬁcult.

The capital inﬂows in the ﬁrst half of the 1990swere mainly portfolio.

Only one third consisted of DFI. A few countries, notably Chile, adopted

restrictions on short-term capital inﬂows, but most were only too happy

to capture whatever foreign resources were available.

The result was a

dangerous increase in speculative capital and an excessive dependence on

foreign capital for ﬁnancing domestic investment.

The ﬁrst evidence that the increase in debt was unsustainable came

with the Mexican ﬁnancial crisis in 1994.Dubbed the ﬁrst such crisis of

the twenty-ﬁrst century by Michel Camdessus (the IMF’s Director at the

time), the Mexican crisis led to an unprecedented rescue package mounted

by the IMF and coordinated by the United States. Mexico avoided default

See Ricardo Ffrench-Davis and S. Grifﬁth-Jones, eds., Coping with Capital Surges: The Return of

Finance to Latin America (Boulder, CO, 1995).

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Globalization and the New Economic Model in Latin America 147

and the spreads on Latin American bonds returned to their previous levels,

but it was an ominous warning of the difﬁculties that lay ahead.

The tequila crisis, as it was known, only temporarily reversed the net

inﬂow of capital to Latin America. This continued almost unabated until

the end of 1998.Atthis point, the Asian ﬁnancial crisis, coupled with the

Russian default in August 1998, led to a reassessment by creditors of Latin

American risk. Thus, the ability of governments and companies in Latin

America to borrow their way out of difﬁculty came to an end as the century

closed.

There have been three circumstances under which Latin American coun-

tries have been able to cope with the new debt reality. First, some countries

(discussed later) have been able to increase the size of their export sectors in

relation to GDP. Just as South Korea escaped the 1980s debt crisis because

it was able to export its way out of trouble, so a handful of Latin American

countries has been able to bring down the ratio of debt and debt servicing

to exports through rapid growth of the export sector.

Second, some countries – for reasons explored subsequently – have been

able to ﬁnance a growing proportion of their current account deﬁcits

through DFI rather than debt. The inﬂows of DFI were linked to the

process of privatization in Latin America, reaching a peak in 1998. They

declined rapidly thereafter, however, as the opportunities for privatization

came to an end in most countries.

Third, many Latin American countries are too small to be attractive to

foreign private creditors. Portfolio investors will not invest in equity markets

with small turnover and little liquidity. Governments of such countries ﬁnd

it difﬁcult to issue bonds. As a result, smaller Latin American countries have

been dependent on ofﬁcial sources of capital, which is subject to conditions

as well as being rationed.

The generalized debt crisis of the 1980s did not, therefore, repeat itself

in the 1990s, even if some countries had very serious debt problems. Brazil

came close to a moratorium in 1998 before the devaluation of the real in

January 1999 and again in 2002 in the run-up to the presidential elections.

Ecuador defaulted on its Brady bonds in 2000 and Argentina defaulted on

most of its foreign debt at the end of 2001. And Cuba’s debt problems have

been so severe that it has been in arrears with almost all its creditors since

the early 1980s.

The net transfer of resources had once again turned negative by 2002.

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148 Victor Bulmer-Thomas

The policies to tackle the debt crisis were being adopted at the same

time as globalization was advancing in the rest of the world. This made

it particularly difﬁcult to meet the challenge of globalization and raised

the possibility of contradictory policies. Tariffs, for example, needed to

be raised to create a trade surplus to meet debt service payments, but

needed to be lowered to promote the trade liberalization favored by globa-

lization.

The Southern Cone countries had experimented with neoliberal policies

in the 1970s, but these had been overwhelmed by the debt crisis and went

into reverse. It was not until 1984 that Chile once again felt conﬁdent

enough to return to the trade liberalization policies it had adopted so

aggressively after 1975.Ecuador ﬂirted brieﬂy with tariff reductions in 1984,

but Congress – not for the ﬁrst time in recent Ecuadorian history – stymied

the neoliberal instincts of the executive.

The most important shift away from ISI, however, came in Mexico in

1985, with the decision by the de la Madrid administration (1982–8)to

join GATT. At a stroke, the quantitative restrictions that had underpinned

Mexican industry for decades came under ﬁre and a program of tariff

reductions was also agreed. Those other Latin American countries that had

not yet applied to GATT all did so in the following years so that by the

end of the century, every Latin American and Caribbean country except

the Bahamas was a member of the WTO (GATT’s successor).

The Mexican government’s decision had less to do with globalization,

a word that had only just been coined, and more to do with the need to

expand the export sector. Paradoxical though it may seem, reducing tariffs

and NTBs is often the ﬁrst step toward promoting exports. The reason

is the impact of import restrictions on the exchange rate, which tends to

become overvalued, and the increase in costs of export production from

high tariffs on imported inputs.

Mexico’s trade liberalization policies led to a deepening of its trade links

with the United States. The non-oil share of exports, most of which goes to

the United States, went from 20 percent in the early 1980sto80 percent in

the early 1990s. At that point, Mexico began to negotiate its entry into the

free trade agreement launched by the United States and Canada in 1989. The

result was the North American Free Trade Agreement or NAFTA, which

came into force on January 1, 1994.

This has led to a further deepening

On NAFTA, see G. Grayson, The North American Free Trade Agreement: Regional Community and

the New World Order (Lanham, MD, 1995).

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Globalization and the New Economic Model in Latin America 149

of the trade ties between Mexico and the United States, to the point where

Mexico now accounts for half of all trade between the United States and

Latin America.

This bilateral trade is not, however, typical of trade between the

United States and Latin America. Mexico’s trade with the United States

consists mainly of manufactured goods and is largely intra-industry. Indeed,

eight of the top eleven Mexican imports from the United States now fea-

ture in the top eleven Mexican exports to the United States.

And Mex-

ico has become very dependent on exports to the United States, which

accounted for 31 percent of GDP in 2000.

Not surprisingly, Mexico went

into recession in 2001 as a result of the economic slowdown in its northern

neighbor.

Elsewhere in Latin America, trade liberalization has been less successful.

Tariffs have been reduced everywhere and some countries such as Bolivia

and Chile have adopted a uniform tariff. However, export performance has

been overwhelmingly affected by the value of the real exchange rate. This

has often moved in the “wrong” direction. Thus, when trade barriers are

reduced, the real exchange rate should depreciate, providing an additional

incentive to exporters.

Why was the movement in the real exchange rate so perverse? In many

countries, trade liberalization occurred just as capital returned to Latin

America. The net inﬂows pushed up the value of the real exchange rate

and encouraged imports, but not exports. This was the problem in Mexico

from 1990 to 1994,inArgentina after 1991, and in Brazil from 1994 to 1998.

As a result, export performance in many countries has been modest and

Latin America’s increasing share of world exports is mainly attributable to

Mexico.

The disappointing performance of the export sector was one of the

reasons for the re-evaluation of regional integration. The schemes estab-

lished in the 1960s had been discredited by the debt crisis because they

were so strongly associated with ISI – albeit at the regional level. How-

ever, a new attempt was made in the 1990stolaunch integration schemes

that would promote exports without encouraging protection against third

countries. The Central American Common Market was relaunched in 1990,

SeeVictor Bulmer-Thomas and S. Page, “Trade Relations in the Americas: MERCOSUR, the

Free Trade Area of the Americas and the European Union,” in Victor Bulmer-Thomas and James

Dunkerley, eds., The United States and Latin America: The New Agenda (Cambridge, MA, 1999).

SeeBulmer-Thomas, Regional Integration in Latin America, 85.

See ECLAC, Statistical Yearbook for Latin America and the Caribbean (Santiago, 2002), 341.

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150 Victor Bulmer-Thomas

the Caribbean Community (CARICOM) in 1992, and the Andean Pact

(renamed the Andean Community) in 1995.

The most innovative new integration scheme was the Mercado Com

del Sur (MERCOSUR), formally adopted in 1991. Linking Argentina,

Brazil, Paraguay, and Uruguay (Bolivia and Chile became associate mem-

bers in 1996), it had a clear political purpose as well as economic objectives.

When the Clinton administration announced in 1994 United States sup-

port for a Free Trade Area of the Americas (FTAA), MERCOSUR was quick

to negotiate as a bloc to prevent the United States from dominating the

hemispheric agendaon regionalintegration. However, MERCOSUR’s early

promise was not fulﬁlled. The common external tariff was never adopted in

full and the scheme suffered from the economic instability brought about

both by external shocks and the absence of macroeconomic coordination.

Trade liberalization is only one of the ways in which Latin America has

adjusted to globalization. Just as important has been the liberalization of

the capital account of the balance of payments and a new approach to

foreign capital. The old hostility to DFI, so strong in the 1970s, has gone

and country after country has introduced new legislation to promote DFI,

with very few sectors or activities reserved for domestic capital.

As part of this new approach to DFI, all Latin American governments

have divested themselves of state-owned enterprises (SOEs). A few of these

behemoths still exist, particularly in the oil industry, but they are now the

exception rather than the rule. Even Cuba has participated in this process of

privatization, with the added twist that the purchase of the assets is restricted

to foreigners. Elsewhere, domestic private groups have been active in the

purchase of SOEs, but so have foreigners. As a result, the stock of DFI has

surged in public utilities, airlines, railways, and steel companies and other

sectors where SOEs were previously common.

It is perhaps in the mining sector that the transformation has been most

marked. Latin America has a long history of discrimination against DFI

in mining, going back to the formation of YPF (an oil monopoly) by the

Argentine state in 1922,ifnot before. The rationale for this was complex and

included resentment at foreign company practices, rent-seeking by cash-

strapped governments, and nationalism. Yet, nearly two centuries after the

end of colonialism in most of Latin America, it is still the mineral resources

On all these regional integration schemes, see Bulmer-Thomas, Regional Integration in Latin America.

Intraregional trade in MERCOSUR was particularly badly hit by the Argentine ﬁnancial crisis in

2001/2, when imports were reduced by 60 percent.

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Globalization and the New Economic Model in Latin America 151

that most attract foreign companies. Thus, Latin America had little choice

but to liberalize access of foreign capital into the mining sector if it wanted

to receive DFI.

The liberalization of the capital account has not been limited to DFI.

On the contrary, for most of the 1990s, the foreign investment coming to

Latin America has been private portfolio capital. This has not been in the

form of bank lending, the dominant form of foreign capital in the 1970s,

but bonds and, to a lesser extent, equity. Trade credits from banks and

other short-term loans have continued but, in general, the international

banks were only too quick to seize the opportunity for exit offered by

the Brady bonds. The growth of the international bond market has been

dramatic and the main Latin American governments and companies tapped

into it with relative ease. They were given a head start by the issuance of

Brady bonds that transformed what had become almost an exotic form of

Latin American debt into one with broad appeal. Furthermore, this foreign

currency market was open to nationals (both companies and individuals),

providing a welcome hedge against devaluation and an opportunity for

portfolio diversiﬁcation.

The international bond markets offered Latin America an opportunity to

issue debt at lower real interest rates than in the shallow domestic ﬁnancial

markets. This was so even after making allowance for expected exchange

rate movements, provided that the country risk premium could be held to a

moderate level. Governments therefore put a huge effort into reducing the

risk premium through sophisticated “road shows” in New York and London

and greater transparency on the ﬁscal accounts and rules on company

disclosures.

These efforts did not go unrewarded by the ratings agencies. By the

beginning of 2003, Chile had been given A- on its long-term foreign cur-

rency debt; Colombia – despite the high levels of domestic violence –

received BB; and El Salvador, which had been embroiled in civil war as

late as the early 1990s, was awarded BB+.

The ratings agencies were more

circumspect about the big three (Argentina, Brazil, and Mexico), although

Mexico was rewarded with investment grade status during 2000 as the era

of the one-party state ﬁnally came to an end.

The ratings, modest country risk premiums, and low international inter-

est rates all encouraged Latin American governments, as well as larger

SeeWorld Bank, WorldDevelopment Indicators, 262–4. The ratings quoted are those awarded by

Standard and Poor.