Professor Alejandro Diaz-Bautista, Economic Policy, Debt Crisis Presentation

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The Debt Crisis in Latin America
Alejandro Díaz-Bautista, Ph.D. ,
adiazbau@gmail.com

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Professor Alejandro Diaz-Bautista, Economic Policy, Debt Crisis Presentation

  1. 1. Economic Policy in Latin America IRGN 409 April-June, 2008 The Debt Crisis in Latin America Alejandro Díaz-Bautista, Ph.D. [email_address] Professor of Economics and Researcher at COLEF Visiting Research Fellow and Guest Scholar 2008, Center for U.S.-Mexican Studies, University of California San Diego (UCSD). April 2, 2008 Graduate School of International Relations & Pacific Studies IR/PS University of California, San Diego
  2. 2. Debt Crisis in the 1980’s <ul><li>The Latin American debt crisis was a financial crisis that occurred in the early 1980s (and for some countries starting in the 1970s), often known as the &quot;lost decade&quot;, when Latin American countries reached a point where their foreign debt exceeded their earning power and they were not able to repay it. </li></ul><ul><li>In the 1960s and 1970s many Latin American countries, notably Brazil, Argentina, and Mexico, borrowed huge sums of money from international creditors for industrialization; especially infrastructure programs. </li></ul><ul><li>Between 1975 and 1982, Latin American debt to commercial banks increased at a cumulative annual rate of 20.4 percent. This heightened borrowing led Latin America to quadruple its external debt from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region's gross domestic product (GDP). </li></ul>
  3. 3. Sebastian Edwards (1995) Crisis and Reform in Latin America: From Despair to Hope. Sebastian Edwards. Oxford University Press. <ul><li>The book is an optimistic overview of the reform process in Latin America from 1982 to 1994 by the World Bank's chief economist for Latin America and the Caribbean and Professor at UCLA. </li></ul><ul><li>The book examines economic policymaking, often drawing on the excellent comparative work of recent years. He recognizes that just as experts failed to anticipate the Mexican default of 1982, which set in motion the Latin American debt crisis of the 1980s, they underestimated the depth of the Mexican peso crisis in December 1994. </li></ul>
  4. 4. Sebastian Edwards (1995) Crisis and Reform in Latin America: From Despair to Hope. Sebastian Edwards. Oxford University Press. <ul><li>Edwards acknowledges the role of the debt crisis and outside pressure from the multilateral lending agencies and the United States in stimulating market reform. Edwards attributes the reform consensus primarily to the failure of various stabilization policies (Argentina and Brazil) and a reinterpretation of the experience in Chile, where antipoverty programs were combined with market economics after the return to democracy. </li></ul>
  5. 5. The Debt Crisis <ul><li>In the 1980s, the world experienced a debt crisis in which highly indebted Latin America and other developing regions were unable to repay the debt, asking for help. </li></ul><ul><li>The problem exploded in August 1982 as Mexico declared inability to service its international debt, and the similar problem quickly spread to the rest of the world. To counter this, macroeconomic tightening and &quot;structural adjustment&quot; (with liberalization) were administered, often through the conditionality of the IMF and the World Bank. This crisis involved long-term commercial bank debt which was accumulated in the public sector. </li></ul><ul><li>The governments of developing countries were unable to repay the debt, so financial rescue operations became necessary. </li></ul>
  6. 6. The Paris Club is an informal group of financial officials from 19 of the world's richest countries, which provides financial services such as debt restructuring, debt relief, and debt cancellation to indebted countries and their creditors. Debtors are often recommended by the International Monetary Fund after alternative solutions have failed. It meets every six weeks at the French Ministry of the Economy, Finance, and Industry in Paris.
  7. 7. Origins of the Debt Crisis <ul><li>In the 1960s and 1970s many Latin American countries, most notably Brazil, Argentina, and Mexico, borrowed huge sums of money from international creditors in order to foster national industrialization. </li></ul><ul><li>These countries had growing economies at the time so the creditors were happy to continue to provide loans. </li></ul><ul><li>Between 1975 and 1982, Latin American debt to commercial banks increased at a cumulative annual rate of 20.4 %. </li></ul><ul><li>Increased borrowing led Latin America to quadruple its external debt from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region's gross domestic product (GDP). </li></ul>
  8. 8. Origins of the Debt Crisis <ul><li>October 30, 1976. </li></ul><ul><li>Mexican Economic Situation. </li></ul><ul><li>Central Intelligence Agency, secret memorandum. Open Archive, U.S. and Mexican declassified records. </li></ul><ul><li>This document captures the way the peculiarities of the Mexican political system can exacerbate economic crisis. </li></ul><ul><li>“ Economic policy in Mexico, like any other policy, is determined directly by the President.” </li></ul>
  9. 9. Origins of the Debt Crisis <ul><li>José López Portillo y Pacheco (a.k.a. &quot;Jolopo&quot;) was the President of Mexico from 1976 to 1982. Born in Mexico City, López Portillo studied Law at UNAM before beginning his political career with the PRI. He held several positions in the administrations of his two predecessors before being appointed to serve as finance minister under Luis Echeverría, a close friend, from 1973 to 1975. </li></ul><ul><li>López Portillo promoted Mexico's economic development with revenues stemming from the discovery of new petroleum reserves in the states of Veracruz and Tabasco by Pemex, the country's publicly owned oil company. </li></ul><ul><li>López Portillo undertook actions which were highly controversial with respect to the international banking establishment. One of his last actions as president, announced during his annual State of the Nation address on September 1, 1982, was to order the nationalization of the country's banking system. </li></ul><ul><li>López Portillo was the last nationalist president to emerge from the ranks of the PRI, and advocate of the ISI Economic Policies. Subsequent presidents have all been U.S.-educated advocates of free trade. </li></ul>
  10. 10. Origins of the Debt Crisis <ul><li>Famous quotes by Ex President Lopez Portillo. </li></ul><ul><li>“ Defenderé el peso como un perro!” </li></ul><ul><li>Six months earlier, after promising to defend the peso &quot;like a dog&quot;, López Portillo devalued the national currency by 40%. After leaving office, he was reportedly unable to appear in public without being barked at, and his luxury, five-mansion became known as Dog Hill. </li></ul><ul><li>En el mundo de la economía los paises se dividen en dos: los que tienen petróleo y los que no lo tienen. ¡Y nosotros lo tenemos! </li></ul><ul><li>&quot;In the world economy, countries are divided in two: those that have oil and those that don't have it. And we have it!&quot; </li></ul>
  11. 11. <ul><li>López Portillo six-year term of office, from 1976 to 1982, coincided with the discovery of massive oil reserves and the tripling of oil production, raising Mexico to the status of the world's fourth biggest producer. This stimulated uncontrolled government spending and foreign borrowing. When the economy overheated and the oil price fell, the country was hit by capital flight and the debt crisis started. </li></ul>
  12. 12. Start of the Debt Crisis <ul><li>As interest rates increased in the US and in Europe in 1979, debt payments also increased making it harder for borrowing countries in Latin America to pay back their debts. </li></ul><ul><li>While the dangerous accumulation of foreign debt occurred over a span of years, the debt crisis began when the international capital markets became aware that Latin America would not be able to pay back its loans. </li></ul><ul><li>This occurred in August of 1982, when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no longer be able to service its debt. In the wake of Mexico's default, most commercial banks reduced significantly or stopped new lending to Latin America. </li></ul><ul><li>Much of Latin America's loans were short-term, causing a crisis when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced, were now due immediately. </li></ul>
  13. 13. 1982 Mexico Debt Crisis <ul><li>By mid-1981, Mexico had falling oil prices, higher world interest rates, rising inflation, an overvalued peso, and a deteriorating balance of payments spurred massive capital flight. </li></ul><ul><li>This disequilibrium, along with the virtual disappearance of Mexico's international reserves, by the end of 1982, forced the government to devalue the peso three times during 1982. The devaluation further fueled inflation and prevented short-term recovery. The devaluations depressed real wages and increased the private sector's burden in servicing its dollar-denominated debt. </li></ul>
  14. 14. 1982 Mexico Debt Crisis <ul><li>Cut off from credit, the government declared an involuntary moratorium on debt payments in August 1982, and the following month it announced the nationalization of Mexico's private banking system. </li></ul><ul><li>By late 1982, incoming President Miguel de la Madrid had to reduce public spending drastically, stimulate exports, and foster economic growth to balance the national accounts. </li></ul>
  15. 15. Export Oriented Economic Policies substitute ISI in Latin America <ul><li>In response to the crisis most nations abandoned their Import Substitution Industrialization (ISI) models of economy and adopted an export-oriented industrialization strategy, usually the neoliberal strategy encouraged by the IMF. </li></ul>
  16. 16. 1982 Mexico Debt Crisis <ul><li>Mexico's GDP grew at an average rate of just 0.1 percent per year between 1983 and 1988, while inflation stayed extremely high. </li></ul><ul><li>Total investment fell at an average annual rate of 4 %. </li></ul><ul><li>Throughout the 1980s, the productive sectors of the economy contributed a decreasing share to GDP, while the services sectors expanded their share, reflecting the rapid growth of the informal economy. </li></ul>
  17. 17. 1982 Mexico Debt Crisis
  18. 19. Getting out of the Debt Crisis <ul><li>Several trade policies before NAFTA, were aimed at expanding trade and inducing growth in Mexico. The De la Madrid and Salinas de Gortari administrations implemented substantial unilateral trade liberalization policies before NAFTA. </li></ul>
  19. 20. Economic Regression Analysis of Mexico in the 80’s and 90’s <ul><li>We can use regression analysis, to study the importance of openness on the rapid growth of Mexican trade since the 80’s. Trade liberalization began with Mexico's unilateral reduction and homogenization of import tariffs, implemented by the administrations of Presidents de la Madrid and Salinas de Gortari. The reduction of import tariffs were followed by reductions of trade and investment barriers through the NAFTA framework. A dummy variable with value one is created since 1986 to 1998 represent unilateral trade liberalization and a dummy variable with value one is created for 1994 to 1999 in order to represent NAFTA’s contribution to liberalization. </li></ul>
  20. 21. Economic Regression Analysis of Mexico in the 80’s and 90’s <ul><li>We can compare the impact of these two trade openness policies compared against the autarky period of the previous stage (1970-1982). We can control for the effect of exchange rate policies with the variable showing the devaluation of the Mexican peso. Two alternative measures of devaluation are used, the rate of change of the nominal exchange rate, and a dummy variable with value 1 for years when the rate of change was larger than 50%. </li></ul>
  21. 24. Regression Results <ul><li>Diaz-Bautista (2003) empirical analysis and regression results supports the proposition that unilateral trade reforms and NAFTA have been effective in expanding Mexican trade and economic growth. </li></ul>
  22. 25. What led to the debt crisis of the 1980’s in Argentina? <ul><li>Corruption and politically unstable country ruled by a military regime leftover from the 1970’s that retarded economic growth and investment. </li></ul><ul><li>Heavy regulated ISI economy and government support for inefficient businesses with subsidies. </li></ul><ul><li>Overvalued Argentine peso and out of control government budget. </li></ul>
  23. 26. <ul><li>What were the economic impacts caused by the debt crisis during the 1980’s in Argentina? </li></ul><ul><li>Hyperinflation reaching recorded high of 4900% in 1989 from excess money supply to finance an inefficient government. </li></ul><ul><li>Financial instability of the Argentine peso in the 1980’s because of extensive dollar denominated debts and rise in interest rates. </li></ul>
  24. 27. The impact of Inflation in Argentina
  25. 28. <ul><li>Rapid rising unemployment during the late 1980’s. </li></ul><ul><li>Slow and erratic economic growth with negative gross domestic product GDP during the mid 1980’s. </li></ul><ul><li>Argentina became a debtor nation during most of the </li></ul><ul><li>decade because of a negative current account balance . </li></ul>What were the economic impacts caused by the debt crisis during the 1980’s in Argentina?
  26. 29. How did Argentina solve the Debt crisis of the 1980’s? <ul><li>In 1991, Argentina implemented radical monetary reforms which pegged the Argentine peso to the United States dollar and limited the growth in the monetary base by law to the growth in reserves. Inflation fell sharply in subsequent years. The 1991 &quot;Convertibility Law&quot; (Ley de Convertibilidad) established a quasi-currency board. </li></ul><ul><li>This was necessary to stabilize the export and import </li></ul><ul><li>sectors and a prevent a further depreciating </li></ul><ul><li>Argentine peso. </li></ul>
  27. 31. <ul><li>Reduced production in the public sector by Privatizing state owned business and reducing or eliminating government subsidies. In 1991 Argentina reduced barriers to trade and implemented tax reforms. </li></ul><ul><li>Things stared to improve for Argentina which witnessed growth of its gross domestic product GDP during the early 1990’s and inflation declining to 0.2% in 1996. </li></ul><ul><li>However, foreign debt remained a problem which Argentina’s Current account deficit increased to -$8,370 million by 1992. </li></ul>How did Argentina solve the Debt crisis of the 1980’s?
  28. 32. Paraguay <ul><li>Population (2005) </li></ul><ul><li>6,158,000 (101st) </li></ul><ul><li>GDP (PPP) 2005 estimate </li></ul><ul><li>Total $28,342 billion (96th) </li></ul><ul><li>Per capita $4,555 (107th) </li></ul><ul><li>HDI (2007)= 0.755 </li></ul><ul><li>Currency: Guaraní (PYG) </li></ul>
  29. 33. Paraguay <ul><li>Paraguay weathered the Latin American debt crisis of the 1980s rather well. </li></ul><ul><li>As the fastest growing economy in Latin America for most of the 1970s, Paraguay prospered while many of its neighbors struggled. Paraguay's debt grew from under US$200 million in 1972 to US$842 million by 1980, but with rapid growth in GDP, debt as a percentage of GDP remained low at approximately 15 %. </li></ul><ul><li>Unlike many neighboring economies in the 1970s, which borrowed to compensate for balance-of-payments deficits or inefficient state-owned enterprises, Paraguay's minimal lending generally went toward productive investment in infrastructure, hydroelectricity, and agriculture. </li></ul><ul><li>About 80 percent of Paraguay's debt was with official creditors, not commercial banks, allowing for greater flexibility and more favorable terms of loan repayment. </li></ul><ul><li>Latin America as a region, owed more than 70 percent of its debt to commercial banks in 1987. </li></ul>
  30. 34. Paraguay’s Debt in the 1980’s <ul><li>Paraguay's debt, however, grew rapidly in the 1980s, at the second fastest rate in Latin America. </li></ul><ul><li>From 1980 to 1987, Paraguay's indebtedness more than doubled, to roughly US$2 billion. Because of Paraguay's slow economic growth during that period, debt as a percentage of GDP increased to above 50 percent. </li></ul><ul><li>Paraguay's rapidly growing debt in the 1980s mirrored that of its neighbors for the first time in the sense that loans were destined primarily to cover the capital and operating costs of state-owned enterprises. </li></ul><ul><li>In 1986 the government was unable to make its payments on a debt to Banco do Brasil; rescheduling this debt blemished Paraguay's previously untarnished credit rating. </li></ul><ul><li>In the late 1980s, Paraguay's national indebtedness grew. </li></ul>
  31. 35. Paraguay’s Economy <ul><li>Paraguay has a market economy marked by a large informal sector. This sector features both reexport of imported consumer goods to neighboring countries, as well as the activities of thousands of micro enterprises and urban street vendors. </li></ul><ul><li>A large percentage of the population, especially in rural areas, derives its living from agricultural activity, often on a subsistence basis. </li></ul><ul><li>On a per capita basis, real income has stagnated at 1980 levels. </li></ul><ul><li>Economists attribute Paraguay's poor economic performance to political uncertainty, corruption, limited progress on structural reform, and deficient infrastructure. </li></ul><ul><li>The economy has rebounded between 2003 and 2007, posting modest growth each year. </li></ul>
  32. 36. <ul><ul><ul><li>The 1980s were characterized by a crisis over developing country debt. </li></ul></ul></ul><ul><ul><ul><li>The shift to contractionary policy by the U.S. led to: </li></ul></ul></ul><ul><ul><ul><ul><li>The fall in industrial countries' aggregate demand. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>An immediate and spectacular rise in the interest burden debtor countries had to pay. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>A sharp appreciation of the dollar. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Debt crisis began in August 1982 when Mexico’s central bank could no longer pay its $80 billion in foreign debt. </li></ul></ul></ul></ul><ul><ul><ul><li>By the end of 1986 more than 40 countries had encountered several external financial problems. </li></ul></ul></ul>Conclusions for the 1980’s Debt Crisis
  33. 37. Conclusions <ul><li>The onset and aftermath of the debt crisis during the so-called lost decade of the eighties led many countries in Latin America to abandon the inward-oriented, state-led, ISI economic development model that had been in place for the better part of four decades. </li></ul><ul><li>In its place was substituted an outward-oriented model heavily reliant on market forces. </li></ul><ul><li>Almost two decades latter the picture is mixed. Economic growth did not pick up as expected during the nineties, leading to some disappointment in some countries with market oriented reforms. </li></ul>
  34. 38. References <ul><li>Díaz-Bautista, Alejandro (2003), Los Determinantes del Crecimiento: Convergencia, Instituciones y Comercio Internacional, México, Editorial Plaza y Valdes. </li></ul><ul><li>Edwards, Sebastian (1995) Crisis and Reform in Latin America: From Despair to Hope, New York, Oxford University Press, pp. 15-40 (Chapter 2) </li></ul><ul><li>Sachs, Jeffrey D. (1985) External Debt and Macroeconomic Performance in Latin </li></ul><ul><li>America and East Asia, in Brookings Paper on Economic Activity No. 2. pp.523-573 </li></ul><ul><li>Sachs, Jeffrey, Aaron Tornell, and Andres Velasco (1996) The Collapse of the Mexican Peso: What have we Learned? Economic Policy (April) pp.15-63. </li></ul><ul><li>Time Magazine. http://www.time.com </li></ul>
  35. 39. The IMF <ul><li>The International Monetary Fund (IMF) was created in 1944, with a goal to stabilize exchange rates and supervise the reconstruction of the world's international payment system. Countries contributed to a pool which could be borrowed from, on a temporary basis, by countries with payment imbalances. </li></ul><ul><li>The IMF describes itself as an organization of 185 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty. </li></ul>
  36. 40. The Balance of Payments (BOP) <ul><li>In economics, the BOP measures the payments that flow between any individual country and all other countries. It is used to summarize all international economic transactions for that country during a specific time period, usually a year. The BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers. </li></ul>
  37. 41. What led to the debt crisis of the 1980’s in Brazil? <ul><li>Oil shocks of the 1970’s doubled the price of imported oil into Brazil. </li></ul><ul><li>Political red tape preventing reforms to bring inflation under control. </li></ul><ul><li>Uncertainties regarding the future of the economy increased world interest rates raising as high as 14.08% by 1981. </li></ul>
  38. 42. <ul><li>Excessive and unnecessary borrowing to maintain a </li></ul><ul><li>high growth strategy by state enterprises. </li></ul><ul><li>Overvalued Brazilian currency led to reduced exports. </li></ul><ul><li>Bankruptcy laws preventing state enterprises from </li></ul><ul><li>going bankrupt which transferred the burden of debt to </li></ul><ul><li>the government. </li></ul>What led to the debt crisis of the 1980’s in Brazil?
  39. 43. What were the economic impacts caused by the debt crisis during the 1980’s in Brazil? <ul><li>Increase in public debt and high interest rates led to major economic problems for Brazil such as a bankrupt public sector with accelerating inflation of 1800% by the end of the 1980’s. </li></ul><ul><li>Negative Gross domestic product GDP growth. </li></ul><ul><li>Unemployment increased more than 6% during Brazil’s 1981-1983 deep recession before moving the economy back to full employment at 3.6% by 1986. </li></ul>
  40. 44. <ul><li>Appreciation of the Brazilian currency during the beginning of the 1980’s against the US dollar that led to a recorded surplus with their trading partners. </li></ul><ul><li>Reduction in inflow of direct foreign investment led to </li></ul><ul><li>negative foreign savings as Brazil became a debtor </li></ul><ul><li>nation with its current account raising to 16.3 billion. </li></ul>What were the economic impacts caused by the debt crisis during the 1980’s in Brazil?
  41. 45. Brazil’s Negative Current Account Balance During the 1980’s The current account of the balance of payments is the sum of the balance of trade (exports minus imports of goods and services), net factor incomes (such as interest and dividends) and net transfer payments (such as foreign aid).
  42. 46. How did Brazil solve the Debt crisis of the 1980’s? <ul><li>Economic reforms were introduced in the 1980’s and 1990’s that included price freezes, readjustments and freezes on wages, rents and mortgages, and a fixing the exchange rate to 1 real per US dollar. The plan’s objective was to eliminate inflation. </li></ul><ul><li>Other reforms included removing restrictions on free enterprise, foreign trade, increasing competition, privatizing public enterprises, and improving efficiency of goods and services by state-owned enterprises. </li></ul>
  43. 47. How did Brazil solve the Debt crisis of the 1980’s? <ul><li>Enacted reforms required by the International </li></ul><ul><li>Monetary Fund (IMF) agreements included: Tax and </li></ul><ul><li>Pension reforms, changes working laws, Bankruptcy </li></ul><ul><li>law, and Independence of the Central Bank. </li></ul><ul><li>However, few of these programs succeeded in Brazil </li></ul><ul><li>because of its political instability and corruption. This </li></ul><ul><li>Led to two decades of low economic growth and </li></ul><ul><li>increases of social problems. Economic growth was </li></ul><ul><li>low because of very high government deficits leading </li></ul><ul><li>to inflation and the devaluation of the real during the </li></ul><ul><li>1980’s and 1990’s. </li></ul>
  44. 48. Economic Policy in Latin America IRGN 409 April-June, 2008 The Debt Crisis in Latin America Alejandro Díaz-Bautista, Ph.D. [email_address] Professor of Economics and Researcher at COLEF Visiting Research Fellow and Guest Scholar 2008, Center for U.S.-Mexican Studies, University of California San Diego (UCSD). April 2, 2008 Graduate School of International Relations & Pacific Studies IR/PS University of California, San Diego

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