Commentary: Down in the Dumps in Latin America

With growth slumping, is the region headed for another lost decade?

By Geri Smith

When night falls in Buenos Aires, poor Argentines start pawing through garbage bags outside restaurants, in search of their family's next meal. In Arequipa, Peru, violent protests recently forced the government to shelve plans to privatize power plants. Many Venezuelans are agitating for the ouster of their President as the currency plummets. Meanwhile, Brazil's Central Bank chief is scrambling to reassure jittery investors that the country's massive public debt is payable even if a leftist triumphs in October's presidential election.

Concerned by the turbulence, U.S. Treasury Secretary Paul H. O'Neill will travel to Brazil and Argentina at the end of July to see how Washington, which has adopted a hands-off approach for most of the past year, can help those beleaguered nations. What he will see isn't pretty: disillusioned voters, panicky investors, rising unemployment, swooning currencies, and leaders desperate for solutions.

It might be tempting for the Bush Administration, its hands full dealing with the domestic U.S. financial crisis, to view Latin America's problems as a regrettable but temporary consequence of unprecedented global economic turmoil. Yet the forces at work in Latin America may be longer-lasting and more pernicious. After a decade of free-market reforms that dramatically improved the region's physical infrastructure but failed to generate sustained growth, jobs, and poverty reduction, Latin Americans are losing faith in the virtues of open markets. Indeed, Latin America appears to be slipping into another "lost decade."

Investors and policymakers remember all too well the previous lost decade. That was in the 1980s, when a string of Latin countries defaulted on their foreign debt, plunging much of the region into a deep recession and starving economies of credit and investment. The human cost was huge. Between 1980 and 1989, per capita gross domestic product fell by nearly 1% per year on average.

Then, Latin America seemed to begin a new chapter. Growth revved up in the mid-1990s, as governments stamped out inflation and courted foreign investors. Peru clocked 8.6% growth in 1996 and Argentina expanded 8% in 1997. But the party did not last long. Today, with a few exceptions, much of Latin America is either stagnant or in crisis. "The region is in very serious trouble," says Riordan Roett, director of the Western Hemisphere program at Johns Hopkins University. "We're in for a long period of stop-start reforms, muddling-through, and populism that will put it even further behind the Asian tigers."

Latin America still has not managed to shake free of its historic boom-and-bust pattern. The double whammy of the Asian and Russian crisis laid much of the region low, and growth has since faltered. Since 1998, it has averaged just 1.5% a year, only slightly above the anemic 1.1% of the 1980s. It's expected to fall to zero this year. "We already have racked up a half-decade of stagnation in per-capita GDP," says José Antonio Ocampo, executive secretary of the U.N.'s Economic Commission for Latin America & the Caribbean (ECLAC). "Some of us thought the expectations raised about the effects of the reforms were unrealistic. Unfortunately, we were right."

Even if growth rebounds to 3% or so--respectable by U.S. standards--it would still fall far short of what Latin America needs to make a lasting dent in entrenched poverty. "We're creating a huge social problem. We need at least 4% to 5% growth a year," says Ernesto Heinzelmann, president and CEO of Brazil's Embraco, a maker of refrigeration systems with annual sales of $646 million. Heinzelmann is speaking of Brazil, but he might as well be referring to the entire continent.

Because most Latin American countries haven't done enough to modernize their economies, build dynamic export sectors, or boost internal savings rates, they remain dependent on foreign capital. "The problem is these countries don't realize that going halfway in reforms is as dangerous as doing nothing--it's like building half a dam," says Drausio Giacomelli, an analyst at J.P. Morgan Chase & Co. in New York. Argentina is the classic example of an incomplete Latin reform. It smothered inflation by pegging its currency to the dollar--but failed to rein in spending and got hooked on foreign borrowing.

The Bush Administration has adopted a tough-love approach, arguing that Latin countries need to do more to help themselves. "Latin America...made some good reforms in the '90s," says U.S. Treasury Under Secretary John B. Taylor. "[But] there needs to be more in the way of things that will raise growth."

Taylor is right. But it's the rare Latin politician nowadays who dares wave the free-market banner. "It's going to be very hard to win an election if you say you're going to globalize, privatize, and do structural reforms," says Moisés Naim, editor and publisher of Foreign Policy magazine and a former Venezuelan Finance Minister.

Populism is on the rise, helping spur a flight of credit from the region. Yield spreads on Latin bonds over U.S. Treasuries, a traditional measure of country risk, have soared above 1,000 basis points. It isn't just Wall Street that's spooked. Even the more steel-nerved multinationals and other foreign direct investors are retrenching. Inflows of foreign direct investment into Latin America were down 30% in 2001 from their 1999 peak of $105 billion. Many expect another sharp drop this year.

The worst-case scenario would be a Brazilian debt default. Some ratings agencies put the risk of that in the neighborhood of 30%. Luiz Inácio "Lula" da Silva, the candidate of the leftist Workers Party, is the current front-runner in the presidential election. Fears that Lula will steer the country onto a populist path have sent the real down 20% since January. That has pushed up the cost of servicing the country's $290 billion public debt, much of which is indexed to the exchange rate. "If the level continues to rise, we'll have a debt crisis," says Alberto Borges Matias, an economics professor at the University of Sao Paulo. Coming hard on the heels of Argentina's $141 billion debt default in December, a Brazilian default could trigger a regional chain reaction.

A dark prospect. Yet this does not have to be Latin America's fate. The region would do well to follow the lead of Chile and Mexico, which have prospered by making exports the pillar of their development. Even they are vulnerable these days, though they are better off than their neighbors. Unless the region's reform movement regains its momentum, these two countries will remain the exception rather than the rule.

Smith covers politics and economics in Latin America.

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