This piece was originally published on Project Syndicate on October 29, 2016.
Center-left and populist governments’ hegemony in Latin America for most of the last decade now seems to be coming to an end, with center-right parties rising to power in Argentina, Brazil, Guatemala, Paraguay, and Peru.
We should not be surprised that Latin America’s “red tide” is receding. Historical evidence from the last 40 years shows that political cycles within the region are highly synchronized, and tend to reflect economic booms and busts.
Nonresident Senior Fellow - Global Economy and Development
But this period turned out to be the proverbial calm before the storm. The party was cut short in the early 1980s, when then-Federal Reserve Chairman Paul Volcker took away the punch bowl, by engineering a sudden interest-rate hike to stem inflation. The “Volcker shock” created a triple whammy: the US entered a deep recession; commodity prices plummeted; and Latin America’s capital inflows abruptly reversed, shifting toward US dollar-denominated instruments that offered better yields.
What followed was a “lost decade” of economic depression, stagnant growth, and currency, debt, and banking crises, as Latin American countries’ output contracted or collapsed. This severe downturn created widespread social discontent, and with the fall of the Berlin Wall and the end of US support for military regimes in the region, every Latin American dictatorship except Cuba’s was upended.
For the most part, center-right, democratically elected governments replaced the military dictatorships, and they exchanged the previous economic paradigm – import substitution, state intervention, and overregulation – for the Washington Consensus, which called for fiscal discipline, price stability, trade and financial liberalization, privatization, and deregulation.
By the early 1990s, the 1989 Brady Plan had resolved Latin America’s debt crisis by providing debt relief in exchange for economic reforms, and interest rates in the US had fallen. Foreign capital flooded in again, and the new consensus view was that bond-driven capital inflows would impose market discipline on Latin America’s historically profligate governments, because, presumably, only credit-worthy agents would be able to borrow. Another bonanza ensued, which Latin American policymakers at the time attributed to the Washington Consensus.
Democracy, together with sensible and credible economic policies, seemed to have finally done the trick. But then came the 1997 Asian financial crisis and the 1998 ruble crisis, in which the Russian government defaulted on its debt. Capital fled emerging markets, sending Latin American countries into another nosedive and resulting in economic depression and more currency, debt, and banking crises.
In the early 2000s, Latin America’s economic malaise again gave rise to social discontent, and center-right governments started to fall like dominos, to be replaced by center-left – and, in some cases, populist – administrations.
The new center-left governments, unlike their populist peers, did not repudiate previous commitments to fiscal discipline, low inflation, and open markets. Rather, they built lavish social-welfare and economic-redistribution programs on top of those commitments. This was possible only because of the boom in commodity prices that began in 2003, and the surge in capital inflows until 2012, as developed-country investors searched for yield in the wake of the 2008 global financial crisis.
Once again, high commodity prices and cheap, abundant capital had fueled a decade-long economic boom. And once again, governments in the region attributed their economic success to the reigning paradigm, which this time combined economic orthodoxy with redistributive policies. What’s more, center-right governments had peacefully transferred power to the newly elected center-left governments, which led many people to believe that this time would be different.
They were wrong. Starting in 2012, Latin American economies cooled significantly, owing to the European debt crisis, China’s slowdown, collapsing commodity prices, and capital flight from emerging markets, as rattled investors sought refuge in safe assets. Some Latin American countries faltered, and others fell into deep recessions.
Latin American governments had again convinced not only themselves, but also voters, that their policies were behind the previous boom. When voters’ expectations clashed with the new socioeconomic reality, they took to the streets to protest. Corruption scandals in some countries added fuel to the fire, and a new crop of center-right governments was elected.
Latin America’s 40-year history of political swings between center-right and center-left governments is evolutionary: each new stage builds upon the previous one. Much like creative destruction, evolution preserves what works, discards what does not, and sometimes adds new, disruptive features.
Assuming this pattern holds, what can we expect from the new crop of mostly center-right, mainstream Latin American governments?
Most likely, they will continue the evolutionary process, by preserving some of the basic Washington Consensus tenets, while pursuing new redistribution policies when feasible. But resources will be scarce, so they will need to redesign social-spending programs and infrastructure projects to maximize efficiency and get more bang for their buck. I call this new paradigm “intelligent austerity.” If Latin American governments implement it successfully, they truly will deserve to claim credit for the economic gains that result.