Deutsche Bank Research

Quo vadis Latin America?

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A few years ago, leading pundits warned of Latin America’s ‘left turn’ and a growing disillusion in the region with free-market policies. In retrospect, it appears as if, politically, 2006/07 was the high-water mark for populism in Latin America. It looks as if the populist model may exhaust itself economically, too. All that is required is a sustained fall in commodity prices. The well-managed economies have sufficient policy space to not only withstand but pro-actively mitigate exogenous shocks. Economies characterised by heavy state interventionism, by contrast, will sooner rather than later face a stark choice: change policies and accept prolonged economic stagnation and adjustment; or run the risk of broader economic and financial instability.

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A few years ago, leading pundits warned of Latin America’s ‘left turn’ (aka populism) and a growing disillusion in the region with the free-market policies that had characterised much of the nineties. A proponent of a so-called ‘Bolivarian’ revolution, very much in the vein of the traditional caudillo, had come to power in Venezuela in 1999. In the mid-2000s, it looked as if other ‘populists’ (that is, politicians who advocated social redistribution and were highly critical of the market reforms of the past) were going to be elected president in a number of Latin American countries, raising the risks of political-institutional destabilisation.

While populist presidential candidates were defeated in Mexico and Peru, they won elections in Bolivia, Ecuador and Nicaragua – three relatively small countries. Argentina had of course already moved away from economic orthodoxy after the financial crisis and economic collapse in 2001/02. It was hoped that a social-democratic, as opposed to a populist and market-critical left, represented mainly by Chile’s Bachelet and Brazil’s Lula, was going to channel electoral discontent into a more market-friendly direction while addressing the demands for social equity without undermining economic growth and financial stability. This is what actually happened.

In retrospect, it appears as if 2006/07 was the high-water mark for populism in the region. Chile, Colombia and Mexico remained poster children of economic orthodoxy. Brazil maintained broadly market-friendly policies, and while Peru recently elected an alleged populist president in 2011, broad economic discipline and market-friendly policies have thus far remained in place. Nonetheless, concerns about social inequality and the perception that the higher economic growth of recent years (chart) benefitted a narrow elite rather than the population as a whole remain important factors in Latin American countries as diverse politically as Bolivia, Chile and Peru.

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Brazil, in particular, appeared to show the way. Its affordable, well-targeted bolsa familia programme offered not only high social and economic but also political returns. Lula and his hand-picked successor, Dilma, won repeated presidential elections. It demonstrated that social grievances can be addressed in a cost-efficient, market-friendly way. Nonetheless, the populist governments in the region opted for less market-friendly policies, ranging from heavy government intervention (e.g. price controls) to full-scale nationalisation, often accompanied by growing economic vulnerabilities (e.g. inflation). Moreover, heavy-handed government intervention rather than market-oriented policies was typically preferred to cope with perceived or real economic challenges. Governments in Argentina, Bolivia, Ecuador and Venezuela have nationalised (foreign) companies in the past few years. Brazil, Chile, Colombia, Mexico and Peru have not.

It looks as if the populist model is about to exhaust itself sooner rather than later. All that is required is a sustained fall in commodity prices (chart). After all, it is probably no coincidence that the five-year economic growth rate is higher than the ten- and fifteen-year growth rate in almost all countries. Rising commodity prices and a favourable terms-of-trade shock have surely played an important role in the Latin American growth story of the past ten years. It is telling that Mexico, unique among the larger Latin American countries for being primarily a manufacturing exporter, actually experienced lower economic growth. This can be largely attributed to the negative terms-of-trade shock it suffered, including low-cost manufacturing competition from China.

Unlike the LatAm-5, the economies of Argentina, Ecuador and Venezuela remain unprepared for a negative commodity-price shock. In the case of Argentina and Venezuela, relatively solid external balance sheets combined with capital controls may allow these countries to avoid an outright financial crisis. But a sustained drop in commodity prices would prove economically and financially debilitating, thus undermining the economic viability and the electoral appeal of these governments’ policies. The LatAm-5, by contrast, have pursued policies that resulted in a tangible improvement in economic fundamentals, thus creating sufficient policy space to not only withstand but pro-actively mitigate a commodity shock.

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(By Markus Jaeger) Published with kind permission of Deutsche Bank Research.

 

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