Economics: World Bank diet too harsh for Latin America

MADRID - Latin America has long been touted as the next big thing in world economic development. By the end of the 1970s, newly industrialising nations there and in Asia were poised to compete with Europe and the United States in the global market place. But while the Asian 'tigers' fulfilled their promise during the 1980s, development in Latin America went into reverse.

Sebastian Edwards, the World Bank's chief Latin American economist, argued last week that the continent had finally laid the foundations for economic take-off. The Latin American economy has been growing by a little over 3 per cent a year since 1990, but he said governments in the region should now aspire to double this rate and make serious inroads into poverty.

Explaining why Latin America failed where Asia succeeded is of more than academic interest. It lies at the heart of the discussion taking place at the annual meetings of the World Bank and the International Monetary Fund here in Madrid. Both institutions tell developing countries how to run their economies. They provide loans and fund investment projects but attach onerous strings. They tell countries to devalue their currencies, squeeze domestic spending, privatise state-run industries and promote free markets.

But do the World Bank and IMF really understand why some developing countries succeed and others do not? Both have plenty of critics, who believe their analyses are fundamentally flawed - they say the institutions do more harm than good, hindering economic growth, exacerbating poverty and harming the environment.

The 1980s were a dreadful watershed for Latin America. In the two preceding decades, Asia and Latin America both sustained rapid growth of more than 5 per cent a year. But while the Asian economy kept expanding by 5.3 per cent a year in the 1980s, average annual growth in Latin America collapsed to just 1 per cent. Per capita income fell by 15 per cent in Latin America during the decade, but rose by 53 per cent in Asia.

What went wrong? The Fund and the Bank lay the blame firmly at the door of Latin American governments. They were corrupt. They wasted money that flowed in from lenders abroad on consumer spending rather than building up their export industries. They tried too hard to replace imports with domestic production - pointlessly manufacturing goods that could be made more efficiently overseas. They exacerbated the flight of investment funds with inappropriate exchange-rate policies.

The last couple of years have seen another surge of money flowing into developing countries as 'emerging' stock markets have become all the rage. The developing countries received dollars 130m ( pounds 84m) last year, compared with a net outflow of dollars 14m just four years earlier. The IMF argued in its World Economic Outlook last week that this turnaround was in part a reward for virtuous behaviour by both Asian and Latin American governments. They boosted their export capabilities, made their domestic markets more efficient and got their tax, public spending and interest rate policies in order.

But the IMF also warned that some Latin American countries were in danger of squandering the capital inflows of the 1990s in the same way they squandered those of the 1970s. Asian countries have used the money to cut government borrowing and raise investment. In Latin America, the money has been used to boost consumer spending. This has helped widen the region's balance of payments deficit to an alarming dollars 40bn. Asian countries have also been more careful to ensure that capital inflows do not put upward pressure on inflation. The IMF said ominously that countries where capital inflows were not warranted by good economic performance could be in danger if sentiment towards emerging markets turned sour.

So were Latin American governments really to blame for the disastrous performance of their economies in the 1980s? And are they wilfully imperilling another opportunity to catch up with the world's economic leaders? Latin American governments were certainly not blameless for the problems of the 1980s, but the dice may well have been loaded against them from the start.

Ajit Singh, the Cambridge development economist, argued last year in the International Review of Applied Economics that the tough interest-rate policies applied in the US and other leading industrial nations in the late 1970s were bound to inflict greater damage on Latin America than Asia.

Economic growth in Mexico surged in 1977 on the back of an oil boom. This was accompanied by a yawning trade deficit, which the international banking community was initially happy to finance. But Mexico's debt had grown so much by 1982 that the finance suddenly dried up. This devastated its economy. Mexico's debt crisis also encouraged the banks to regard Latin American countries with much greater suspicion than those in Asia. South Korea may well have had a debt crisis in the early 1980s had the banks treated it as they treated the Latin Americans.

Tight interest-rate policies in the industrial countries also slowed world trade growth, cutting demand for developing countries' exports and deepening their trade deficit. But Asia was cushioned by its extensive trade links with the still buoyant economies of the Middle East. Growth in Latin America was strangled as the balance of payments constraint tightened. Imports of capital equipment were curtailed, which eroded the capacity of export industries. Government deficits widened as revenue from import duties and sales tax evaporated.

Mr Singh calculates that the impact of this 'shock' to the Latin American economy was three or four times as severe as the impact on Britain of the oil crisis in the early 1970s. Inflation soared as workers struggled to maintain incomes in the face of economic stagnation and shrinkage.

This experience casts serious doubts on the policy prescriptions of the IMF and the World Bank. The institutions are no doubt right to urge governments to be prudent in their borrowing. But this is difficult in economies subject to tight balance-of-payments constraints. In such cases, draconian attempts to cut government borrowing may be counter-productive.

Demands that countries pull down barriers to trade and capital flows may also be inappropriate. The Japanese had rigorous import controls in the 1950s and 1960s, and Asian countries had much more regulation of capital flows and exchange rates than the Latin Americans. The IMF and the World Bank also argue that the state should not intervene excessively or in a 'market unfriendly' way in industry. But Japan, South Korea and Taiwan have all pursued unashamedly interventionist industrial policies.

The World Bank is none the less right in some of its prescriptions. It urges Latin America to invest more in its infrastructure and to boost domestic savings. It also recommends programmes to improve nutrition, education and health. But enforcing tough macro-economic policies and market liberalisation may be less appropriate as a policy prescription for Latin America than for the rich industrialised nations. If the annual meetings in Madrid end with greater recognition that there is no single model for successful economic development, that would be a valuable achievement.

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