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[CN] Chapter 8

[CH] Political Economy and Economic Policy in Latin America

Economics is concerned with how a society organizes the production and distribution of goods and services. It is easy to imagine how politics could affect economics. It is just as easy to envision how economics might affect politics. We use a number of different approaches when talking about the relation between economics and politics: textbook economics, economic history, economic policy, and political economy. Each needs an introduction.

Textbook economics are what professors teach and students learn in economics courses. They are based on several principles that are shared by all in the profession yet cover a vast array of concrete phenomena. Textbook economics are important not only because they are the foundation of how many of us understand the abstract workings of an economy but also because of their policy impact. Policymakers tailor their plans to accord with what economic theory tells them about how the economy works.

That is why is it important to remember that the economics found in textbooks is not always the same. In the 1950s, when political science began looking seriously at Latin America, economists in North America were generally Keynesians. John Maynard Keynes (pronounced canes) was a twentieth-century English economist who argued forcefully and successfully for an active government role in managing a country’s economy. This was to be done by adjusting taxes, government spending, and interest rates to raise or lower spending by consumers and investors to keep an economy growing steadily. Keynesian theory came into vogue during the 1930s, when the then-current textbook model, classical free-market economics, had no solution to the Depression. However, when the Keynesian view of the world had no answers to the slump of the 1970s, it ceded its place in the texts to a revised form of free-market economics often called neoliberalism. To further complicate matters, Marxists had their own textbooks that patiently and persuasively explained why capitalism was destined to fail.

Economic history sounds simpler and safer. After all, history has already happened. However, the different theoretical orientations that populate economics have their own interpretation of history. To overstate matters, a Marxist view would stress class struggle and history’s inexorable march toward communism, while a free-enterprise theorist would note the beneficent effects of the working of the unregulated market through time. Yet it is imperative to know economic history to properly understand the politics of a place, any place.[1]

History matters in economics just as in any other social science. That is because sectors of an economy rise and fall, as do regions of a country where those sectors are important. As Chapter 3 described, elites linked to established sectors often maintain their political influence even as their economic weight declines. Of equal importance, long reliance on a particular economic sector, such as the automotive industry in Michigan and Ontario, can lead politicians to overlook opportunities for economic diversification or to protect an industry when it might be better to push it toward change. In any case, knowing the economic history of a country or an entire region of countries is an essential part of what is necessary to understand politics in Latin America.

Although economic theory and economic history are commonly used approaches to the study of the economics of Latin America, political scientists feel far more at home talking about economic policy. Obviously, this includes the national budget, but also takes in areas such as banking regulation, competition policy, and consumer protection legislation, to mention just a few. There are numerous ways to examine public policy, but one of the most common is to look at how Latin American governments have managed their economies—the ends sought as well as the tools used. And the central question there is how to account for changed policies.

In making Latin American economic policy, as in other areas of the region’s political life, external models have had great influence. Sometimes these models have been adopted freely by national elites. This was true in the eventual triumph of free trade and Latin American nations’ enthusiastic participation in the global economy as producers of primary products in the nineteenth century. However, at other times, especially since 1900, economic policy has been imposed by external forces, most often the government of the United States. Again, we see why a historical perspective on Latin American politics pays real dividends.

One lesson that emerges from this brief overview of approaches to studying the economic side of Latin American politics is that it would be self-defeating to try to treat politics and economics as distinct phenomena, separated by a firewall. Prescriptions for advancing the region’s economic development have always recognized that government has a role to play, even when that role is limited to setting the rules that permit the economy to prosper. Yet much of political science forgets this. Only political economy bears the politics-economics nexus constantly in mind, because it is consciously interdisciplinary. Political economy examines how the structure of an economy (concentration of wealth, sectoral balance, and so on) affects what governments do and how governmental decisions (taxes, spending, and so on) influence how an economy works.

As with economic theory, history, and policy, political economy also divides along ideological or programmatic lines. One of these is the neoliberal variant of free-market economics. It gives special attention to failed interventionist policies and has been prominent since the 1970s. Another variant is Marxist, and it obviously emphasizes the structural causes of capitalism’s weaknesses. A third, older school is historical in orientation, and thus inclined to be less theoretical and favor description. This chapter tries to balance the contending views, which necessarily means that it comes out more descriptive than theoretical and does not fully embrace the positions associated with any particular school.

In fact, the aim of this chapter is to present the current state of the economies of both Latin America as a region and in a few selected countries. It will discuss questions of structure (for example, which sectors are rising or falling), performance (issues such as growth, poverty, and inflation), and policies (especially the theories behind the policies).

[A] The Latin American Economy Today: Some Data and Interpretations

Sixty years ago, shortly after the end of World War II, although Latin America was a relatively poor region, that poverty was relative to Europe, North America, and Australia and New Zealand. Indeed, the wealthiest countries of Latin America were arguably better off than still-unreconstructed Europe, and even middle-income countries were ahead of Spain and Portugal. In the first decade of the twenty-first century, that is no longer the case. In fact, not only has Latin America been left behind economically by its former colonial masters, but even countries that six decades earlier were far poorer than anywhere in Latin America (possibly excepting Haiti), especially the nations of East and Southeast Asia, are also now better off. What happened?

Answering the foregoing requires three pieces of information. The first is simply the current economic status of the countries of Latin America. The second is similarly straightforward, as it concerns Latin America’s historical economic status as a region. Only the last part is more complex, as it has to do with explanations for Latin America’s economic performance and the related prescriptions for its improvement.

[B] Data

Answering the first question—the current economic status of Latin American countries—is best done by considering national income statistics. These refer only to an economy’s growth and how much bigger it has become, and need not say anything about its development or how diversified and sophisticated an economy is. The first set of statistics (Table 8.1) simply shows current figures for gross domestic product (GDP and for the purchasing power parity, or PPP value of that amount (see Text Box 8.1). Three points stand out. First, Latin America is substantially poorer than its two North American neighbors and its European colonizers. Nevertheless, the World Bank classifies all Latin American countries as either upper-middle-income or lower-middle-income countries, except Haiti, which is a low-income country. Second, nominal per capita incomes in Latin America understate the population’s purchasing power, in some cases significantly. Third, per capita incomes vary widely among countries. Each point merits a closer look.


Table 8.1. National GDP per Capita, 2005

Country GDP ($US) PPP ($US) Classification

Argentina 4,728 14,280 Upper-Middle Income

Bolivia 1,017 2,819 Lower-Middle Income

Brazil 4,271 8,402 Upper-Middle Income

Chile 7,073 12,027 Upper-Middle Income

Colombia 2,682 7,304 Lower-Middle Income

Costa Rica 4,627 10,180 Upper-Middle Income

Cuba n/a 4,500* Lower-Middle Income

Dominican Republic 3,317 8,217 Lower-Middle Income

Ecuador 1,608 4,440 Lower-Middle Income

El Salvador 2,467 5,255 Lower-Middle Income

Guatemala 2,517 4,568 Lower-Middle Income

Haiti 500 1,663 Low Income

Honduras 1,151 3,430 Lower-Middle Income

Mexico 7,454 10,751 Upper-Middle Income

Nicaragua 954 3,647 Lower-Middle Income

Panama 4,788 7,605 Upper-Middle Income

Paraguay 1,400 5,070 Lower-Middle Income

Peru 2,838 6,039 Lower-Middle Income

Uruguay 4,848 9,962 Upper-Middle Income

Venezuela 5,275 6,632 Upper-Middle Income

Canada 34,484 33,375

United States 41,890 41,890

Portugal 17,376 20,410

Spain 25,914 27,169

*: Estimate.

Source: Adapted from UNDP, Human Development Report, 2007/2008. 277–279; World Bank, World Development Report 2008, 333; and CIA Factbook, 2008.

First, Latin America is home to middle-income countries, those with per capita incomes between $905 and $11,115 annually in 2005.[2] What is striking is that none of the countries makes it into the ranks of the wealthy. The economic historian Angus Maddison’s data[3] show that in the past some countries did reach that plateau—for example, Argentina in the 1920s and Venezuela in the 1970s—but they could not hold their places. These are primary product exporters, and as world demand for their products goes, so go their economies. Or as an early twentieth-century Costa Rican president said, “Our best finance minister is a high price for coffee.” To the extent that this is true, a significant part of the region’s economic prospects and problems are tied to foreign demand for raw materials.

A second point that emerges concerns the difference between nominal incomes and PPP incomes. There are only four cases—Chile, Mexico, Panama, and Venezuela—where the PPP is not at least twice the nominal income. This implies low consumer prices, but low consumer prices suggest the likelihood of low wages. In that case, most people will have little money with which to consume goods and services and drive the economy. This is consistent with the extreme levels of income inequality found in Latin America that we saw in Chapter 3.

Finally, if Haiti is excluded as an outlier, the top per capita income in Latin America (Mexico) is about eight times higher than the bottom (Nicaragua). In the old European Union (EU) of 15 countries, the ratio is little more than 5:1, with Luxembourg’s $79,851 leading and Portugal’s $17,376 trailing.[4] However, the new EU of 27 countries has Bulgaria at the bottom, with a per capita income of $3443, 1/23 of Luxembourg’s. Thus there is a relative equality among Latin American states, which is consistent with all but one of them being middle income countries.

Text Box 8.1. Measuring Income

The most common measure of income is gross domestic product (GDP). It is the market value of all final goods produced in a place during a specified time, normally a year, but occasionally a quarter. It also includes the value added at intermediate stages. Formerly, gross national product (GNP) was widely used. GNP is calculated by adding GDP to net income received by residents from nonresident sources (for example, foreign investments). A third measure, gross national income (GNI), is very similar to GNP and is used in some reports by the World Bank.

Any of these measures can be presented in nominal terms (that is, the value of a country’s production expressed in an international currency, usually $US, at existing exchange rates). However, a better way to assess the standard of living that a nation’s income provides is to use the purchasing power parity exchange rate. This rate considers how much a given basket of goods costs in different countries in their home currencies. A simple PPP is the “Big Mac Index” used by the British magazine The Economist. It asks what McDonald’s charges for a Big Mac in different countries and uses this as a rough-and-ready indicator of what the “real” exchange rate between two currencies should be. PPP-adjusted per capita income figures are especially useful in giving a more realistic picture of levels of well-being in poor countries, as a dollar or Euro generally buys more goods and services in a poor country than it does at home.

GDP is often used as the principal indicator of development, but it is better seen as an indicator of economic growth. That is, GDP tells us whether the economy is producing more or less activity that can be measured in money terms. It does not tell us whether there is new activity, greater efficiency, or whether the growth is the result of speculation or an international boom. Neither does it say anything about the uses to which income is put or how it is distributed.

Students of development, who examine how countries or regions increase their material well-being and make their economies more sophisticated, have always had reservations about using GDP, or any other measure of national income, to gauge development. Yes, income measures are easily available and are generally calculated the same way everywhere. Moreover, they are intuitively easy to grasp, as long as we accept that more money is better than less. Yet, as noted above, GDP can obscure important facets of a country’s material status. For that reason, the United Nations Development Program (UNDP) developed its Human Development Index (HDI). The HDI combines measures of literacy and education, life expectancy, and GDP to get a broader picture of how development is progressing in a country.

Table 8.2 shows that although no Latin American country is classified as a high-income country by the World Bank (>$US11,116 per capita in 2005), eight make it into the high HDI rank. Although the benefits in terms of living standards of a high HDI are intuitively easy to grasp, higher levels of human development should also bring more purely economic benefits. A better educated and healthier population should give a country an edge in securing economic growth. This certainly has been the case of the Four Asian Tigers—South Korea, Singapore, Taiwan, and Hong Kong—which grew rapidly in the last quarter of the twentieth century.