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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242 Roberto Cort

es Conde

went to investment in Petrobr

as,tothe construction of the Itaip

u dam,

and to subsidizing production of fuel from alcohol. By 1974, the Brazilian

debt had jumped from 6.2 percent to 11.9 percent of GDP. Foreign debt

was mainly medium and short term, and it was mostly placed in com-

mercial banks, especially after 1973.Bythis time, the debt represented a

substantial accumulation that became Brazil’s main problem for the next

decade. Interest rates were not only higher than those applied by multilat-

eral agencies, but also ﬂuctuating, which would also have a negative bearing

on the future. Inﬂation, after going down until 1973,went up again to more

than 20 percent.

In Argentina, during the ﬁrst part of the period, the government ﬁnanced

the deﬁcit mainly with domestic debt (1960–4). Subsequently, note issues

became the main tool to ﬁnance excess expenditures and only from 1976 on

did the external debt start to play a very important role in closing the gap

between revenues and expenditures. In the 1976–86 period, gross foreign

debt rose to 80 percent of the GDP. In fact, these ten years can be divided

into a ﬁrst period (1976–82), during which the foreign debt increased

US$35 billion, and a second one (1982–6), during which it was difﬁcult to

obtain new funds, and the increase of US$12 billion was mainly explained

by the reﬁnancing of the interest payment.

The alternative was to resort to the domestic capital market. Previously,

governments had imposed forced savings by increasing bank reserves, by

nationalizing deposits, and by inﬂation. In the 1990s, instead, they issued

bonds for the public to purchase, but because the obligations sold through

the banking system paid interest rates lower than the inﬂation rate, to make

them attractive to buyers, they had to be protected from inﬂation by means

of indexation. This opened up a new and important source of ﬁnancing

for the state, but it had an explosive effect for the future because of its

huge accumulation. Governments had been used to eroding their liabilities

through inﬂation and devaluation. From this time on, that would not

happen.

Regarding monetary policy in Brazil, the most important event was the

foundation of the Central Bank in 1964.Uptothat moment, Brazil lacked a

bank with money control and money-issuing powers. Previously, monetary-

policy control powers were assigned to the SUMOC, founded in 1945,

whereas the Bank of Brazil acted both as a bank of issue and a commercial

Osvaldo Schenone, “Public Sector Behavior in Argentina,” in The PublicSector and the Latin American

Crisis, 25.

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Fiscal and Monetary Regimes 243

bank, having rediscount authorization through the CARED (Rediscount

Portfolio) (1945) and the CAMOB (1931). Roberto Campos had designed

an independent Central Bank but in spite of that, in 1967, after a strong

confrontation with the government, the bank lost its autonomy. In spite of

the fact that the 1964 stabilization program was not completely successful,

it allowed institutional changes that had a bearing on the economic results

of the 1960s. It reduced the ﬁscal deﬁcit, reordered the tax system, restruc-

tured the ﬁnancial system (Central Bank, Mortgage National Bank), and

introduced indexation mechanisms, unifying and simplifying the foreign

exchange system.

ForFinance Minister Delﬁm Netto, cost pressures, not demand ones,

determined inﬂation (during the Castelo Branco administration, Roberto

Campos had assumed that inﬂation was caused by demand-pull factors).

Consequently, he adopted an expansionary monetary policy, substantially

increasing credit. Expenditure grew directly because of subsidies given by

the federal government and indirectly through money creation by the

Central Bank. Expenditure was also inﬂuenced by the enlarged govern-

ment entrepreneurial activity (several new state enterprises were created),

especially when the treasury had to ﬁnance its losses.

Between 1964 and 1973, money supply ﬂuctuated between 15 percent

and 18 percent of GDP, though circulation velocity remained stable; after

1973, the relationship went down to 12 percent and in 1980 it represented

8.3 percent. This was the result of the effect of inﬂationary acceleration and

indexation mechanisms on ﬁnancial assets (other than currency), causing

economic demonetization.

In Argentina, after 1976, the Central Bank, which had been ﬁnancing

the treasury, began to spend directly by creating money to subsidize foreign

currency purchases and foreign reserves, but above all, in the 1980s, by

remunerating bank deposits in the Central Bank (encajes). When the gov-

ernment had more limited access to ﬁnancing, it raised bank reserves and

remained with a substantial part of commercial banking deposits, which

were remunerated. This was called quasiﬁscal expenditure and was a sig-

niﬁcant source of deﬁcit. Until 1974, changes in the Central Bank reserves

practically compensated rediscounts and subsidies granted. Consequently,

the Central Bank’s quasiﬁscal expense was almost insigniﬁcant. In 1974,on

the contrary, the fall in reserves reﬂected a negative quasiﬁscal expenditure

equivalent to almost 4 percent of GDP. The fall in currency reserves con-

tinued in 1975,resulting in a quasiﬁscal expenditure of 3.4 percent of GDP.

In 1976, there was a substantial change, to positive quasiﬁscal expenses of

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244 Roberto Cort

es Conde

about 2.25 percent of GDP as a result of the 180-day swap granted in 1975,

so as to induce private capital inﬂow. The subsidy for currency futures sales,

at preferential prices, was about 5 percent of GDP.

In Mexico, during the stabilizing development period, the main source

of ﬁnancing for the deﬁcit had come from the banking system through

high reserve requirements. Because the ﬁnancial markets were still under-

developed, the government did not ﬂoat any bonds. The Central Bank lent

funds acquired from the banks to the Treasury. From 1970 to 1976, total

credit from the Central Bank to the public sector grew 12 percent a year on

average in real terms. Because external borrowing was restricted, internal

debt with the Central Bank was adjusted in keeping with the government’s

budget constraint.

After 1973, inﬂation occurred and expectations of devaluation appeared,

causing capital outﬂows. To secure additional funds for the government,

the Bank of Mexico increased the reserve ratio, from 34.8 percent in 1971

to 51.1 percent in 1976.Even this measure proved insufﬁcient to meet the

needs of the public sector. The response was to boost the currency issue at

an annual real rate of growth of 11 percent. The increase in the monetary

base more than matched the fall in the money multiplier. For this reason,

the average annual rate of growth of M1 in nominal terms was almost

20 percent. This expansion fueled inﬂation and increased the balance of

payments problem that culminated in the 1976 devaluation.

In contrast, total credit to the public sector from the Central Bank

grew at a moderate pace from 1977 to 1979.With the ﬁscal deﬁcit still

within reasonable proportions and the wide availability of foreign credit,

the authorities were able to control the expansion of domestic credit and

the monetary aggregates.

In 1981, there was a sharp reduction in oil prices, ﬁscal revenues shrank,

and the ﬁscal deﬁcit soared to 13 percent of GDP. As a consequence of

public ﬁnance imbalance, the debt reached 58 percent of GDP and debt

payments were more than 30 percent of total expenditures. Economic

growth was a negative 1 percent and there was a huge outﬂow of capital.

After acurrency depreciation of 479 percent, the state nationalized the banks

and transformed dollar deposits into peso deposits. In August 1982, the state

defaulted on the foreign debt and began making the efforts needed to bal-

ance the situation.

Schenone, “Public Sector Behavior in Argentina,” 21–2.

Hierro and Sangin

es, “Public Sector Behavior in Mexico,” 159.

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Fiscal and Monetary Regimes 245

CONCLUSIONS

The period of the formation of nation-states coincided with the constitu-

tion of a tax state, where national ﬁnances were modernized, jurisdictions

established, and tax revenues more efﬁciently managed. The nature of taxes

changed. In the past, they had mainly consisted of monopoly contributions

and taxes on domestic trade or the indigenous population. From then on,

the tax system centered on foreign trade. The uniﬁcation of nation-states

was ﬁnanced by customs duties, which increased substantially as exports

expanded. In those countries whose exports enjoyed a dominant position

in the market, export taxes–away in which government participated in

natural resources’ rents – were the main source of their income (mainly

Brazilian coffee and Chilean copper). That was not the case with other

exports, where taxes would have negatively affected a huge number of

producers; there, taxes were mainly levied on imported consumer goods.

As a rule, the increase in tax collections made it possible to put an end to

civil wars and to consolidate the nation-state, which, during most of the

nineteenth century, survived precariously within a framework of poverty

and war. Although military expenditures declined, those destined to pay

off earlier debts increased. In spite of this constraint, governments became

more accountable and public works were built, making the export boom

possible.

In colonial times, only silver coins were used as a means of payment, to

which convertible bank notes, treasury notes, or government inconvertible

paper money were added. For long periods, notes had a forced circulation.

In several countries, private or mixed banks of issue were founded, acting

as government ﬁnancing agents. By the early twentieth century, there were

several efforts to adopt the gold standard with a pure Currency Board system

or some variation of it.

The sharp drop in imports during World War I led to a general crisis.

However, the hardest constraints were imposed by the long-lasting depres-

sion of the 1930s, with its catastrophic reduction in international trade

and capital ﬂows. That meant important institutional changes. Up to this

point, most governments had relied on taxes that were easy to collect,

such as mineral royalties or import taxes collected at ports. The latter were

generally transferred to prices (and, therefore, not felt as a government exac-

tion, especially if of moderate weight). To replace this system, new taxes

on proﬁts, income, or wealth were adopted, raising stronger opposition.

Latin American governments tried several reforms, but none was successful

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246 Roberto Cort

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in raising sufﬁcient revenues to cover the vastly expanded list of govern-

ment social and economic responsibilities. From then on, and until the end

of the century, various ﬁscal reforms were attempted, all of which proved

unsuitable as foundations for the Leviathan state created in the 1930s.

Prompted by the sharp reduction in revenues from foreign trade, gov-

ernments sought new revenue sources of easy collection. On the one hand,

governments sought to increase their share of rents from the export of natu-

ral resources. On the other hand, departing from the gold standard entailed

substantial devaluations, which represented excess proﬁts for exporters who

were earning in foreign currency and spending in local depreciated currency.

Resorting to exchange controls, Brazil and Argentina established multiple

exchange rates and collected an exchange differential, which represented

for certain periods of time a share in the revenue they had created with the

devaluations.

During the 1920s and 1930s, central banks were founded throughout

Latin America. Formerly, governments had used banks of issue to place

short- or long-term debt, but in the new world order, where international

capital markets had disappeared, central banks monopolized money issue

and were under government control, becoming the main source of ﬁnanc-

ing. In some cases, ﬁnancing was obtained by appropriating private savings,

through a rise in bank reserves (Mexico), which were remunerated. In oth-

ers, ﬁnancing was directly obtained by issuing money (Argentina, Chile,

and Brazil), though this had an inﬂationary impact. Although, at ﬁrst, this

mechanism was used to solve problems created by the depression through

raising revenues, providing liquidity to banking systems, and ﬁnancing

public works, in the following decades, it would be deliberately used to

foster industrial growth.

In the postwar period, the new methods of state ﬁnance pioneered in

the 1930swere improved and deepened by several Latin American govern-

ments to implement their new industrial policies. At the same time, big

social changes took place, such as rural migrations, urbanization, increased

number of industrial workers, and unionization. Those social changes

meant new demands and pressures to develop new activities. Nonethe-

less, the Latin American governments were unable to adopt substantial

reforms that might have provided sufﬁcient taxes. Instead, governments

preferred to ﬁnance their activities through the appropriation of the natu-

ral resources’ rents (whenever prices were favorable) or taxes on labor (social

security system contributions and inﬂation). Rent generation was supposed

to encourage investment and provide income to be reinvested, promoting

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Fiscal and Monetary Regimes 247

growth and a more equitable income distribution. However, the results of

these mechanisms were different than expected: inﬂation, fall in exports,

crisis in the balance of payments that limited the development process, and

aworsening of income distribution.

The scheme of growth and equity with inﬂationary ﬁnancing had already

showed its weaknesses in the 1950s. The following decades were spent in the

search for more reliable sources of revenue. A more favorable international

framework, where international trade recovered and limitations to capital

movement were gradually dropped, made it possible to obtain capital

abroad and, for certain key sectors such as infrastructure and transportation,

direct investments were made. Without abandoning the state’s dominant

role in the process, investment was encouraged via exchange incentives or

captive markets.

However, more was required for external capital to ﬂow in sufﬁcient

quantities. It was necessary to ensure macroeconomic stability in order to

guarantee the currency in which proﬁts would be made and the availability

of remittances. This posed an extremely difﬁcult task. Procedures used in

the postwar era had created remarkable imbalances in the currency, public

ﬁnance, and the foreign sector. Coming back to balance implied tough

adjustments, with expenditure and credit reduction, which affected those

sectors that had grown under the protectionist scheme (and had eroded

their debts and subsidized their capital formation). Numerous stabilization

programs were attempted, with varied results. Most created recessions,

generating extremely strong opposition, which made those programs fail,

unleashing new devaluations and inﬂationary processes. In some cases,

reforms showed some positive results in the long run because a more ordered

state came out of them (Argentina and Brazil during the 1960s), and a more

modern economy. Attracting foreign capital required guaranteeing that no

capital losses would result from inﬂation. This implied that debt should be

issued with monetary correction indexes or ﬂoating interest rates. Within

the new international ﬁnancial context, this widened the debt market but

implied a heavy burden for the future. The situation became more difﬁcult

because the foreign debt had been taken at low interest rates, something

that changed when the United States raised rates to unprecedented levels

at the end of the 1970s. This made debts more burdensome and called

into question the region’s capacity to pay. Massive capital ﬂight took place,

leading to new devaluations and inﬂation.

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EXPORT-LED INDUSTRIALIZATION

richard salvucci

INTRODUCTION

The title of this chapter requires, perhaps, some explanation. Accounts

of trade and production in Latin America between 1870 and 1930 typically

focus on the development of export economies; describe commodity cycles,

their causes, and consequences; and attend, to a lesser degree, to the begin-

nings or acceleration of industrialization. Although I accept this scheme

and, to an extent, follow it, the rationale for this chapter is different. For one

thing, accounts of the commodity cycle are numerous, and the best ones

can scarcely be bettered. For another, the emphasis on export economies,

although by no means incorrect, is nevertheless somewhat misleading.

Industrialization in Argentina, Brazil, Chile, Colombia, Mexico, and Peru

was not independent of international trade, much less opposed to it, but

complementary to, consistent with, or even consequent upon the expansion

of the external sector. Even the advent of the railroad in Latin America, once

understood primarily as a means of facilitating the production of exportable

goods, is now known to have had a powerful impact on the domestic mar-

ket in some places, such as Argentina, and was less associated with interna-

tional trade in others, such as Mexico, than commonly supposed. Marco

Palacios (the reader may consult the bibliographical essay for the litera-

ture mentioned in the text) has questioned the validity of the export-led

model of growth in Colombia. Export-led growth did not begin in the

1870s but rather commenced in the twentieth century: only a small share

of Colombian agricultural output – perhaps 10 percent – was exported.

And although there were places, like Cuba, in which a conventional

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250 Richard Salvucci

model in which a large part of infrastructure and industrial value added

was the result of the spread of sugarcane, the welfare consequences of this

development seem more debatable than they once were.

In this sense, the decline of the dependency model, so inﬂuential and

fruitful to a previous generation of scholars, has proved liberating. It is

not simply a matter of new ﬁndings but, more important, of new ques-

tions and novel explanations. The ﬁnding that open economies following

comparative advantage enjoyed high and, indeed, sometimes surprising

levels of domestic income comes as no surprise to students of conven-

tional theories of economic development. But by implication, such studies

locate poor domestic economic performance squarely in the conﬁguration

of domestic policies, politics, and institutions. They must shift the research

program of scholars to aspects of constitutional and political organization;

public ﬁnance and ﬁnancial architecture; the deﬁnition and assignment of

property rights; and even to education, all of which are more promising

explanations for “underdevelopment” than the simple distributional con-

sequences of international trade. And the literature on economic “conver-

gence,” broadly deﬁned as the tendency of low-income economies to grow

more quickly than their high-income counterparts, necessarily raises inter-

esting but disturbing questions for Latin America. Why did the successful

economies, such as Argentina, Cuba, and perhaps Chile, poised for inte-

gration into the world’s upper-income ranks, “diverge” or ﬁzzle out after

promising beginnings? Was it luck, poor policies, changes in the world

economy, or “weak foundations”? The intellectual framework of export

economies does not easily accommodate all of these issues, many of quite

recent vintage.

The ﬁnal reason for departing from the framework of export economies is

heuristic. In recent years, international economic historians have demon-

strated intense interest in the workings of the gold standard. Although

much of the research is driven by new techniques of time-series analysis or

concerned with drawing policy lessons about currency regimes, its impli-

cations for Latin America are intriguing. Older studies of the gold standard

in Argentina and Chile have now been updated, and there is new work

on Brazil and Mexico as well. The attraction of these studies lies in their

intellectual coherence, for they provide a systematic study of the difﬁculties

inherent in maintaining a balance between domestic and external perfor-

mance under ﬁxed exchange rates. At the same time, for those economies

that went to gold later, the silver standard was profoundly affected

by international economic trends that altered the rough equilibrium

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Export-Led Industrialization 251

that prevailed between gold and silver in the post-Napoleonic world. Con-

cretely, the rapid and deep depreciation of silver against gold after 1872

that persisted into the middle 1890s effectively placed Mexico, Peru, and

Central America on continuing exchange devaluation, a development that

affected export performance and the strength of the export-oriented elites.

Moreover, in the face of unstable or persistently deteriorating terms of

trade, ﬁxing the exchange rate in terms of gold had consequences, such as

substantial swings in output, that have been insufﬁciently understood. So,

this approach makes for a somewhat different account of a ﬁeld that has

changed dramatically in the past thirty years.

ABRIEF OVERVIEW OF TRENDS IN

PRODUCTION AND TRADE

First, a few ﬁgures. According to the British statistician, Michael Mulhall

(1829–1900), in his The Progress of the World,“the states of South America

are little more than half a century old, and yet they have made considerable

progress, especially in the last twenty years.”

Argentina, where he resided

for some time, was an especial example of material advance, but Brazil and

Chile, too, Mulhall observed, “[have] left the others far behind.” In his

History of Prices Since the Year 1850,heargued that Argentine wealth per

head, £130,exceeded the European average (£123) given the low levels of

southern Europe and Russia.

Even Mexico (£90 per head) had attained

the levels of Spain and Portugal, although it lagged far behind that of the

neighboring United States (£190). If anything, tiny Uruguay (£152) was still

more impressive. The point of citing Mulhall is not to argue that his ﬁgures

were strictly accurate, even if modern research supports his conclusions

about the relative afﬂuence of Argentina. Instead, it was the dynamic of

growth in the mid to late Victorian era that impressed him. At the aggregate

level, at least, there were places that shared in the “progress” of the Victorian

boom of which Mulhall was an avatar.

Still, the devil is in the details, and the details of growth and trade

are not easy to come by. Later, we assemble a number of statistics, some

more reliable than others, to document the pace and pattern of growth for

many countries over a long period. Here, coverage is somewhat limited, but

Michael Mulhall, The Progress of the World (Shannon, Ireland, 1971; orig. publ. London, 1880), 471.

Michael Mulhall, History of Prices Since the Year 1850 (London, 1885), 112.