Globalization as a Development Strategy in Latin America?

World Development Vol. 31, No. 12, pp. 1977–1995, 2003� 2003 Elsevier Ltd. All rights reserved

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lddev.2003.09.002
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Globalization as a Development Strategy

in Latin America?

OMAR SANCHEZ *

University of Oxford, UK

Summary. — The swinging of the pendulum toward policies that enhance Latin America’s insertioninto the world economy diverted attention from domestic policies that continue to be essential forgrowth and development broadly defined. Six domestic policy areas are identified here: increasingdomestic savings, implementing countercyclical fiscal policies, mobilizing public resources,investing in education, promoting employment, and reducing income inequality. The opportunitycost of not having devoted due attention to these issues throughout the 1990s is surely enormous,and for those countries still underplaying domestic variables, the longer the delay the greater thecosts. The imperative of devoting more political capital to domestic strategies of developmentcannot be overstated––whether international financial institutions choose to emphasize them ornot.� 2003 Elsevier Ltd. All rights reserved.

Key words — globalization, Latin America, development strategies, education, fiscal policy,

inequality, employment, taxation, savings

The bad road is that which explains the national stateof affairs purely in terms of the dependency with re-spect to an international order which must be com-pletely overhauled; the good road, on the otherhand, is that which leads to a greater capability for ac-tion and analysis of those forces that need to be mobi-lized, the obstacles to be overcome, and the strategiesto be adopted. The shape these roads take on in LatinAmerica shows that they lead to opposite directions––(Alain Touraine). 1

*Final revision accepted: 16 June 2003.

1. INTRODUCTION

Globalization is viewed as a reliable substi-tute for a domestic development strategy. Thatis the conclusion any casual observer can cometo by hearing the policy advice of the world’smajor international development organizationsand mainstream economists. Combining inte-gration into the world economy and goodgovernance will deliver the fruits of develop-ment, the underdeveloped world is told. Whenit comes to economic policy advice, that istoday’s zeitgeist. Some have called this aWashington Consensus-plus formula, as it ispresumably a modified version of John Wil-

197

liamson’s original ‘‘consensus:’’ an indispens-able complement to economic liberalization is astate that performs certain essential tasks ef-fectively and matches its actions to its cap-abilities (World Bank, 1997). The questionremains: is this a genuinely new developmentagenda or simply the same neoliberal prescrip-tion in new clothes? Whatever the case, LatinAmerica has wholeheartedly embraced the faithin open trade and freer capital markets and yet,subsequent growth is well short of expectations.The exuberant optimism that the reformagenda generated a decade ago has given wayto a more cautious, subdued mood.The stylized facts explain this new mood.

After 10–15 years of reform experience, LatinAmerican economic performance leaves muchto be desired. GDP growth throughout the1990s for the region as a whole has averaged3.2% a year, not nearly enough to make, byitself, a dent on poverty. When populationgrowth is factored in, it means that regional percapita annual incomes have increased by apaltry 1.1%. World Bank figures show that 36%of 500 million Latin Americans were poor in1998 (i.e., earned less than $2 a day), comparedwith 38% in 1989. Those in extreme poverty

7

WORLD DEVELOPMENT1978

(i.e., living on less than $1) were 16%, barelydown from 18% ten years earlier (The Econo-mist, 2000). In sum, the devastating effects ofthe debt crisis have not been significantly re-dressed by the performance of the subsequentdecade. Poverty figures, both relative and ab-solute, are worse today than they were 30 or 40years ago. Although both poverty (less than $2a day) and absolute poverty (less than $1 a day)levels decreased throughout the 1990s, progresshas been halted in the last few years. Further-more, the aforementioned 3.2% average growthfor the 1990s hides high-growth volatilitythroughout the decade. This makes for muchpoorer economic outcomes (including employ-ment, income distribution, savings, investmentand others) than if that growth had beenreasonably steady. In a recent authoritativeassessment of the reforms, the EconomicCommission for Latin America (ECLA) isforced to conclude with an apparent paradox:‘‘the biggest policy changes in a generation. . .resulted in fairly modest changes in perfor-mance at the aggregate level’’ (Stallings &Peres, 2000, p. 203). The upshot is that LatinAmerica is steadily falling behind other coun-tries which were once at similar levels of de-velopment (measured as GDP per capita).Whether globalization––understood in this

article as the increased integration of trade,foreign direct investment, and openness to in-ternational capital markets––is leading toincreased or decreased inequality, increased ordecreased poverty worldwide, depends onwhether we use countries or individuals, andpurchasing power parity or exchange ratesmeasures, as our units of analysis. Askingabout the relationship between globalizationand growth, income distribution, or volatilityon a global scale is interesting, but it hides moreinformation that it reveals––for there is no suchthing as a ‘‘typical country’’ in the worldeconomy. To probe deeper, a more sensibleapproach to measure the effects of worldwideeconomic integration is in relation to the de-velopment position of countries in the inter-national economy. Is the impact of increasedtrade and financial openness on growth andinequality similar in Ethiopia and Chile? Is itsimilar in Chile and France? General and spe-cialized media commentary on globalizationoften conveys the idea that the impact, what-ever it is alleged to be, is more or less uniformacross countries. Reality, however, often defieseasy characterizations. The differential effects ofincreased integration (meaning openness to

trade, Foreign Direct Investment, and capitalflows) on groups of countries at different de-velopmental stages can be readily discerned bysimply using three income categories (high-income, middle-income, and low-income). Yalescholar Geoffrey Garrett adopts this very ap-proach and finds interesting results (Garrett,2001). His regressions show that integrationinto the global economy has had deleteriousconsequences for low-income countries. Withinthese, more open ones have experienced in-creased inequality and lower growth. Amidmiddle-income countries, more integration isassociated with increased growth and lowerinequality, so increasing links with the globaleconomy has been a winning formula. Amongrich countries, more integrated countries haveexperienced increased inequality but enhancedgrowth, a mixed picture. 2

These findings should not however create theimpression that fortunes are fixed according toa country’s GDP per capita or relative positionin the international development ranking. Theforces of globalization as such are not inher-ently beneficial or deleterious for developmentprospects. As has been remarked by manyprominent voices before, they carry risks andopportunities and it is up to developing coun-tries to minimize the former and maximize thelatter via their own domestic policies. Whatincreased economic integration does is to placea premium on some variables (say, education)and enhance the risks on others (say, fiscal ir-responsibility). The process of development (orlack thereof) is endogenously driven: it restslargely upon domestic policies over which de-veloping country governments have control. Itis on the basis of this knowledge that less de-veloped countries should act.This paper proceeds as follows. First, some

of the deficiencies of the globalization-as-development blueprint are briefly addressed.Then, in what constitutes the bulk of the paper,some of the tasks that have been underplayedin the rush to open trade, capital, and directinvestment barriers, are considered. These in-clude: the need to increase domestic savings toenhance domestic economic autonomy andstability, the need to introduce countercyclicalpolicies in the volatile Latin American eco-nomic context, the need to actively promoteemployment rather than passively waiting forgrowth to deliver new and better jobs, and theneed to mobilize public resources more ag-gressively in order to address all manner ofurgent social and economic needs. Finally, re-

GLOBALIZATION AS A DEVELOPMENT STRATEGY 1979

cent economic research lends added importanceto two intimately linked issues that, it is reck-oned, need to acquire much more attentionfrom politicians and policymakers than hasbeen the case in recent years: the region’s edu-cational quantity and quality deficit and thescourge of income inequality. Their interrela-tionship also considered. In the conclusion, aplea to redirect political capital toward thesedomestic areas of policy is made.

2. GLOBAL INTEGRATIONAS PANACEA?

The static benefits of free trade are well es-tablished. Paul Samuelson has famously re-marked that comparative advantage is the onlyconcept in economics that is both true andnontrivial. But what can one say about thedynamic benefits? The answer hinges onwhether the forces of comparative advantagepush a particular economy in the direction ofactivities that generate long run growth. As amatter of fact, the causality link between tradeopenness and long-run growth, contrary topopular wisdom, is not engraved in stone.There are two chief problems encountered inthe empirical literature on this topic. First, it isdifficult to find an adequate way to quantifytrade regimes. 3 Second, it is difficult to disen-tangle the simultaneous causality between tradeand growth. Rodriguez and Rodrik (1999)survey the extensive academic literature on thesubject, and find it wanting. Studies have yet toproduce convincing econometric research notplagued by misspecification or inadequate in-strumental variables (in this case, proxies ofopenness that are uncorrelated to other policyor institutional variables that have a detri-mental effect on growth). In short, there is animportant gap between the policy prescriptionsthat are usually derived from research and whatthat research has actually shown. There arereasons to think, Rodrik argues, that thequestion of whether trade promotes growth islikely to be a contingent one, dependent on anumber of country and external characteristics.In any case, whatever the relative merits of

export promotion as an engine of growth, it isclear that there are diminishing returns to sucha strategy given the context of diminishingworld demand over the long run: the worldeconomy grew at 4.9% per annum during the1960s, at 3.8% during the 1970s, and at 2.9%during the 1980s. World growth during the

1990s also hovers around a disappointing 3%a year. Easy exhortations for Latin Americato strive to reproduce Asian-style export-ledgrowth are misguided for this and other rea-sons. What authoritative studies of LatinAmerica’s economic development in the 1990sshow is that, contrary to received wisdom, theregion’s comparative advantage in a worldsetting rests not so much in its low-skilled laborforce, but in its vast natural resources (Stallings& Peres, 2000). This worries some long-stand-ing observers of the region. Indeed, there maywell be grounds to voice today some of thesame concerns expressed by economist RaulPresbisch half a century ago. Gert Rosenthal, aformer chief of the Economic Commission forLatin America (ECLA), explains such concernas follows:

There exists some similarities [today] to the interna-tional division of labor. . . in 1949; it would be an ir-ony if we came full circle to the realization that, inthe global economy, Latin American countries are tospecialize in commodities subject to a low elasticityof demand on world markets and therefore are to becaught once again in a low-productivity trap. One ofthe main objectives of what we call transformacionproductiva [change in production patterns] is to movein the direction of economic activities with a highervalue added and a higher growth potential (Rosen-thal, 1997, p. 202).

In other words, if indeed many Latin Americancountries are stuck in the production of trad-ables whose demand does not grow at least atthe same pace as world income and if technicalprogress is inherently commodity-saving, thenspecializing in these goods is already and willincreasingly be a losing proposition. That, ofcourse, is the idea behind the Presbisch–Singerthesis. 4 Further, if Latin America is simply notas labor-intensive in its production patterns asAsia was when it pursued its export-orientedpolicies from the 1960s onward, then the bene-fits of openness will not accrue to labor tothe same extent, as predicted by the Stolper–Samuelson theorem, the equalization of theprices of factors of production.To be sure, the role played by the external

sector in economic development has beenoveremphasized worldwide, but perhaps no-where as much as in Latin America. This dis-proportionate attention given to trade andfinancial flows has been particularly pro-nounced in recent years. But it is by no meansnovel. The Latin American obsession with theexternal determinants of development has


clouded good judgment throughout the 20thcentury. Consider what prominent economistCarlos Diaz Alejandro writes:

It does appear possible to argue that the role of theforeign sector in Latin American development has[historically] been exaggerated and indeed mytholo-gized . . . Even in a small country the foreign sectorwill influence only indirectly many key developmentalvariables, such as productivity in non-export agricul-ture, willingness to save and decisions to invest inhuman capital. Income distribution and political par-ticipation will be more influenced by these and otherdomestic variables than by whether effective rates ofprotection are 10% or 150% (Diaz Alejandro,1996, p. 46).

The idea to inculcate here is not that tradeprotection is preferable––no country in the lasthalf-century has achieved higher long-termgrowth from a closed economy model. It issimply to point out that trade openness is beingoversold by the international developmentcommunity as a road to prosperity and that, asa consequence, precious political capital andtime is being diverted from other, more press-ing issues––i.e., the fostering of domestic sav-ings/investment, the enhancement of tax basesand revenues, or the increase in human capitalinvestment. The issue areas that follow are byno means mysterious factors as contributors toeconomic prosperity. They are all too familiar,but an enhanced growth agenda that devotespolitical capital into purely domestic issues hasyet to be nationalized––that is, internalized byLatin American policymaking elites. Althoughsome of these domestic issues do indeed adornthe pages of World Development Reports andinternational development organization publi-cations, they have not been internalized by asignificant mass of the region’s political class. 5

Until that happens, no significant change inpolicy priorities shall be forthcoming. Domesticpolitical consensus at he highest levels of poli-cymaking is essential. As political scientistRajni Kothari has put it:

History has shown very clearly that one cannot con-structively transform a society from the outside. Allgenuine transformations have been initiated fromwithin the society, even though in many cases thegenesis for such transformations lay in the cross-ferti-lization of ideas and experiences from different coun-tries (Khotari, 1993, p. 152).

This crossfertilization of experiences andideas often acts with a significant lag. ManyLatin American countries have been slow to

respond to pressure to carry out fundamentalreform based only on the evidence fromneighboring countries.The international economic environment of

recent years illustrates perfectly well the perilsthat accompany a strategy that relies on entic-ing foreign investors while not working to en-hance economies’ freedom of movement. Aftera decade in which, notwithstanding a couple of‘‘drought periods,’’ capital inflows were gener-ously coming into Latin America, convincingforeign investors to come in is becomingharder. Dornbush offers three reasons for it:

First and most important, the notion that emergingmarkets represent an asset class that deserves itsown allocation has disappeared . . . Next, the worldmoney glut, in which just about anyone can get accessto funds, has passed . . . Lastly a weak center––fromthe US to Europe and Japan––limits Latin America’sexport opportunities and hence its easy growth scenar-ios . . . All this puts the onus on Latin America to gen-erate messages that might entice investors back(Dornbush, 2001, p. 19).

Needless to say, the region would be muchbetter off if growth was self-generated and self-sustained to a greater degree––that is, notnearly so dependent on economic growth else-where and on the sentiments and decisions offoreign investors.

3. THE CENTRALITY OF DOMESTICSAVINGS: ENHANCING ECONOMIC

AUTONOMY

A first victim of the single-minded drive tointegrate economies with the outside world hasbeen the crucial task of mobilizing domesticsavings. Latin America has historically had alow rate of domestic savings. But, besides thelow level, most troubling of all is its evolution:the level has remained stubbornly stagnant,suggesting that powerful structural factors op-erate to keep savings low. The process by whicha given economy that is saving a low percentageof its income increases savings dramaticallyover the long haul has been (and remains) oneof the central tasks for economic developmenttheory to explain. Savings (and accompanyinginvestment possibilities) lie at the heart of eco-nomic growth. Economic theory posits thatsavings can be enhanced by frugal consumptionpatterns, efficient financial intermediaries, pos-itive real interest rates, and by an attractiveinvestment climate in the domestic economy


(Edwards, 1995). Empirical studies reveal that,as regards developing countries, high real in-terest rates do not have a long-term impact onsavings. Out of the mentioned channels, themost feasible is that of restrained aggregateconsumption. The East Asian experiencestrongly indicates that important increases inprivate savings stem from two factors: macro-economic stability and institutions that instillconfidence in small savers (World Bank, 1993).These are obviously factors that are absent inLatin America and can only be expected toarise over a long time horizon.A noted expert on the region, Chilean econ-

omist Sebastian Edwards, points to four mac-roeconomic issues that will be pivotal for LatinAmerica in the near future: first, monitoringcapital movements and avoiding over borrow-ing; second policies that foster domestic savings,particularly private kind; third, investment ininfrastructure that is high enough to spur rapidgrowth; and fourth, the development of insti-tutions that add transparency to macroeco-nomic policy and isolates it from politicalinfluences (Edwards, 1995, p. 306). All thesepolicy areas have one important thread thatunites them, as Edwards points out: the needfor fiscal discipline. Significant progress hasbeen made in this area. The main thrust offiscal adjustment took place in the first half ofthe 1990s. Although the budgetary deficit is animperfect measure to gauge fiscal discipline, it isuseful to note that the average public deficithas come down from about 6.5% in 1980–90to about 1.2% in 1991–96 (Burki & Perry, 1997).But the regional context of slow growth since1998 has had a as correlate a resurgence offiscal deficits in many countries. Although fur-ther fiscal tightening is unwarranted in thisstage of the business cycle, fiscal consolidation(cyclically adjusted) must not be abandonedover the medium and long haul. Governmentsmust maintain a stable macro environment foreconomic agents, and that is why fiscal slippageshould not be allowed to sneak in when thebusiness cycle turns positive. Further, govern-ments should instinctively contribute to totalsavings insofar as conditions allow them. Yet,generating public savings cannot be done atany cost. In Latin America fiscal adjustmenthas all too often taken the form of sizable cutsin infrastructure investment, maintenance ex-penditure, public spending in education andhealth, and other social services. Needless tosay, such cutbacks in physical and humancapital undermine long-term growth.

Empirically speaking, just how important isto increase savings and investment throughoutthe region? The World Bank estimates thata continuous economic expansion on the orderof 6% a year for any given Latin Americancountry will require a minimum investment ratehovering around 25% of GDP. Domestic sav-ings rates currently stand at 15–20% of grossproduct in the typical Latin American econ-omy, comparing very unfavorable to the 30%and higher observed in Asian economies. Cur-rently, only Chile posts an investment rateabove 20% in the region. This deficient state ofaffairs renders the region highly vulnerable. Thereason being that to rely on foreign investmentfor more than 2% or 3% of GDP is to exposethe economy to much greater dependence onexternal circumstance than is necessary (Em-merij, 1997). In short, there is little alternativebut to upgrade efforts to reduce the post-warperiod dependence on foreign investment.Quite simply, a savings mix that relies heavilyon the domestic sort will make for a less volatileeconomy (due to the volatility of capital mar-kets) and one less prone to crises––underminingstability and sustainable economic growth.Some reckon that to boost savings Latin

America must adopt yet more stringent fiscaldiscipline––preferably even generating budgetsurpluses over the long run. This is mistaken.The significant progress in fiscal belt-tighteningachieved in the past decade has had importantpositive consequences for Latin economies––notably, winning the battle against inflation.Persistently high inflation was clearly under-mining savings and investment in many coun-tries. But with inflation rates brought down toreasonably low levels, there is little furtherbenefit to be gained from this effect (Stiglitz,1998). Unlike some analysts predicted (orhoped for), significantly higher fiscal disciplinehas not brought about a meaningful increase inthe level of aggregate savings and investment.Further fiscal austerity is not the easy solutionto inadequate savings in the long term.To attempt to boost domestic savings over

the long run, more and more economists areproposing two types of policy reform: first, fin-ancial sector reforms with the ability to attractsavings from a broad base of the population;second, policies that foster private sector invest-ment––in particular, export promotion, techno-logical development, competitiveness policies,and assistance to Small and Medium Enter-prises (Ramos, 2000; Rosenthal, 1997; Stiglitz,1998). In addition to providing macroeconomic


stability, East Asian economies boosted savingsrates via a variety of institutional measures.They attached great importance to promot-ing savers’ confidence in financial institutions,notably strengthening bank systems via moreeffective prudential regulation and other mea-sures. Although progress has been made inthe 1990s, more remains to be done in LatinAmerica in this regard. An important policyproposal to boost savings is the advent ofgovernment-run postal savings to attractsmaller savers, offering low-income householdsgreater security and lower transaction coststhan private banks––as was successfully donein many East Asian Countries (Birdsall &Jaspersen, 1997). Specific measures aside, eco-nomic history indicates that savings rates in-crease only gradually over a long period.Chile’s long period of rising savings rates sincethe early 1980s indicates that there are no fast,immediate magic bullets; but more happily, italso tells us that a stable macro environmentalong with decisive and steady reform on allareas of economic and institutional life––spur-ring high, sustained growth––can work won-ders for savings. In the final analysis, the basicfact remains that unless growth is boosted(upward from a mediocre level of around 3% in1990s) Latin American aggregate savings willnot rise to required levels. Both private andgovernment savings are affected by real growth.Gavin, Hausmann, and Talvi (1997) have evenmaintained that a fresh look at the stylizedfacts on saving reveals that growth precedessaving, rather than the reverse, and that policiesshould therefore aim to aggressively boostgeneral growth––and savings will follow. Theempirical evidence in favor of this assertion,however, remains controversial. Latin Amer-ican countries must, of course, adopt pro-growth policies more aggressively, but it is hardto think that promoting saving will harm cap-ital formation and growth––as long as coun-tries provide a context of favorable investmentopportunities. Savings should be more stronglyemphasized as an intermediate policy target.But such intermediate policies will do little ifLatin America does not generally move towardmore robust and predictable economies andsturdier institutional settings.The importance of foreign capital flows to

the region during the 1990s is unmistakable. Itis readily observed by simply looking at a graphshowing concurrently net capital inflows andGDP growth rates. As one goes, so does theother. The lack of availability of foreign capital

immediately following the Mexican (1995) andAsian (1997) financial crises has seriously re-stricted growth at those times. Whereas LatinAmerica will have negligible say in what a newinternational financial architecture will looklike, if it ever takes shape, it does have leeway intaking measures to reduce its vulnerability tooutside shocks and also to partially countertheir damaging effect when they occur, as theyinevitably will. (What is more worrying, theorigin of these shocks is often obscure, withweak links to economic fundamentals.) This isall the more so because the prospect of morestable environment in international capitalmarkets in the future is unlikely; rather, theopposite is true. ‘‘Given present trends,’’ arguesCEPAL’s Ricardo Ffrench-Davis, ‘‘interna-tional markets may become even more volatile’’(Emmerij, 1997, p. 474). Argentine economistAldo Ferrer throws light on the coming dangersinherent in the wobbling situation in which theregion finds itself. If current trends continue,

. . . stability will become increasingly dependent on theexpectations of financial markets. The external debtand the dependency of public finances on short-termcapital will tend to subordinate economic policy tomarket decisions: the success or failure of economicpolicy will come to be measured by a policy’s influenceon access to financial markets rather than by its im-pact on production, exports, or jobs (Ferrer, 1997,p. 184).

Indeed, some voices have decried that the‘‘virtual economy has substituted the realeconomy.’’ This is only somewhat of an exag-geration; it certainly captures an importantkernel of truth. It is therefore urgent that LatinAmerican economies find ways to steadily dim-inish their extravagant dependence on foreignsavings and here is yet another reason why themobilization of domestic savings is crucial. Inshort, they are not only crucial for growth, butalso to reduce economic volatility and gainmore leverage over one’s own economic for-tunes.Some may well put forth a general objection:

the very process of globalization means thatnational policies are forced to dovetail withmarket expectations. In other words, there isvirtually no scope for discretion in fiscal,monetary, taxation, and other policy areas. The‘‘straightjacket’’ imposed by global marketsmeans that every policy decision (especiallythose on the macroeconomic front) is scruti-nized carefully by international capital mar-kets––that is, markets ‘‘vote’’ for policies on a


daily basis. Those policy moves that are not tothe liking of investors will be penalized, andsometimes severely. While this picture of realityhas gained credence in recent years, assertingthat there is reduced scope for action is not thesame as saying that there is no scope. Thebottom line is that there exist ways in whichLatin American governments can slowly butsteadily enhance their room of maneuver if theymake a conscious decision to do so. Given re-cent (and not so recent) historical economicexperience this pivotal objective (i.e., the steadyenhancement of economic autonomy) shouldcommand agreement across the political spec-trum and become a politica de estado in allLatin countries––particularly in smaller, morevulnerable ones.

4. THE BENEFITS OFCOUNTERCYCLICAL POLICY:

REDUCING VOLATILITY

A longstanding problem in the region is thatposed by pro-cyclical fiscal behavior––i.e., theconduct of expansionary fiscal policy duringeconomic booms and restrictive fiscal policyduring recessions. Such fiscal conduct only ex-acerbates a region already highly vulnerable toexternal shocks and attendant interruptions ineconomic growth. Gavin and Hausmann (1998)find that Latin American macroeconomic vol-atility (yearly swings in GDP growth rates) isthree times as high as that observed in OECDcountries and more volatile than any regionother than Africa and the Middle East. Half ofthat volatility springs from capital market in-stability, as Latin America’s access to interna-tional financial markets is sporadic and oftendisappears when it would be most valuable. Buta sizable addition to that volatility (about 30%)comes from the fact that fiscal and monetarypolicies in Latin America aggravate, ratherthan smooth, economic cycles (De Ferranti &Perry, 2000). In particular, Gavin and Perotti(1997) show that this pro-cyclicality comesfrom highly pro-cyclical government expendi-ture patterns. It is on the basis of this knowl-edge that both politicians and policymakersshould act upon and take decisive steps to re-verse intertemporal fiscal behavior.In Latin America, the tug-of-war between

congress and the executive branch historicallytends to magnify the effects of recessions byincreasing taxes and reducing spending at thosetimes, while also magnifying the effects of boom

periods with larger-than-normal spending andlower taxation levels. On their part, financeministers, as far as their powers have allowedthem, have strived to substitute the classicalrole of fiscal policy––that is, to maintain a highlevel of aggregate demand when private in-vestment or private consumption declines––bya restrictive fiscal policy oriented toward gain-ing credibility vis-�aa-vis the markets in hopes ofreactivating private spending. They are oftenforced to adopt pro-cyclical policies to adjust toeconomic contractions because Latin countriesabruptly loose access to international creditmarkets at those times. Such drastic loss ofaccess during hard times is partly due to thefickle and herd-type behavior of internationalinvestors and partly due to irresponsible do-mestic economic management (i.e., overspend-ing and overborrowing) during periods offavorable external economic environments, es-pecially times of widespread foreign capitalavailability. That is why the timely applicationstandard Keynesian fiscal policy to smooth theeffects of what have traditionally been roughand accentuated business cycles would serveLatin America well. (As regards monetarypolicy, it has become much more circumscribedby the markets and so there is less scope ofmaneuver in this area.) One of the main rec-ommendations of the 1995 Inter-AmericanBank Development Report Overcoming Vola-tility was that Latin American governmentsmust live within their means during times ofeasy money in order to survive rainy days(IADB, 1995). After almost a decade since sucha public warning was issued, there is little signof improvement on this score.There is no doubt that globalization has

brought about a depolitization of economicpolicy––that is, economic policymaking is lessof a political instrument than used to be thecase, and politicians have less discretion overfiscal and monetary policy management. Manyeconomists welcome this trend. It is they thatpush for fiscal policy to be further away fromthe hands of politicians in order for economiesto gain more credibility vis-�aa-vis the markets,attain temporal consistency, and thereby fosterlong-term investment. 6 Following this line ofreasoning, Chief Economist of the IADBRicardo Hausmann publicly proposed in themid-1990s the establishment of independentnational fiscal councils throughout LatinAmerica to set budget targets that would helpovercome excessive volatility. This institutionwould set countercyclical budget targets that


would build budget surpluses during boomperiods that could later be tapped to maintaininvestor confidence and market credibilityduring recessions (Eichengreen, Hausmann, &Von Hagen, 1999). For governments that havetruly made a disaster out of macroeconomicpolicy discretion, this may be a sensible short-term option, for they may desperately need tobuttress their credibility. But in general, seriousobjections can be raised against the fiscalcouncil proposal on democratic grounds: withmonetary policy already out of the hands ofelected governments, if fiscal policy were tofollow the same route, then elected officialswould have virtually no degrees of freedom inmanaging economic policy, severely under-mining democratic accountability. This ines-capable reality makes fiscal council-typeproposals politically unviable. What is moresensible is to strive toward building a ‘‘socialconsensus’’ as a framework for sound fiscalpolicy, which necessarily involves reworkingand rebuilding the entire fiscal pact betweenstate and society. Discretion over fiscal affairscan be very valuable if spending and taxationtools are used responsibly by the political class,in line with domestic and external economicconditions. At the end of the day, there is nosubstitute for the arduous task of building apolitical culture that fosters fiscal responsibi-lity––a la Chile. Chile is the only Latin Amer-ican country that has truly managed to conducta countercyclical fiscal policy during the pastdecade. The administration of Ricardo Lagos,all too aware of the benefits hitherto derivedfrom the use of countercyclical policy, tookpains to consolidate the countercyclicality im-plemented in previous Concertacion govern-ments by introducing a policy of structuralfiscal surplus of 1% over the course of its ad-ministration. 7

5. MOBILIZATION OF PUBLICRESOURCES: THE PERENNIAL

TAXATION QUANDARY

A second underemphasized area in the roadto development is the mobilization of publicrevenue resources. Are states that command amere 10–15% of their national incomes viableeconomically? Can they build the basis of arisk-reducing welfare state? Do they have theresources to deliver income redistribution? Theanswer is, probably not. Perhaps no othereconomic reform issue is as eminently political

as tax reform. That characteristically LatinAmerican saying, ‘‘inflation is more politicallyacceptable than taxation,’’ speaks volumes.Changing taxation systems is a daunting taskfor policymakers to undertake, for politicallypowerful constituencies defend ferociously thesocially unjust status quo. During the 1980s itwas recognized that the traditional obsessionwith progressivity in the design of tax codeshad the perverse effect of resulting in signifi-cantly reduced receipts for the typical LatinAmerican state. This led to a new orthodoxy––pushed by the International Monetary Fund(IMF), World Bank and the Inter-AmericanDevelopment Bank––which urges countries tosimplify convoluted tax norms, reduce marginaltax rates, expand the tax base, and rely on moreeasily collectable forms of taxation––chiefly theValue Added Tax (VAT). The underlying ideawas that the reduction in receipts broughtabout by reduced marginal rates and dimin-ished trade taxes would be made up (or ex-ceeded) by the expansion of the tax base andbetter administration and enforcement of taxcollection. In general, there has been a markedshift from taxing income to taxing consump-tion. The tax system been eschewed as a meansof correcting inequality. The reasons are wellknown. One has been the recognition that se-rious deficiencies in tax administration renderredistribution via taxation a chimera; second,there was in the late 1980s a downgrading ofthe equity relative to efficiency objective.Although some improvement in revenue in-

takes has taken place during the 1990s, there isa long road to travel. Two important issuesneed to be borne in mind: the new tax struc-tures are unnecessarily downplaying the im-portance of distributive criteria, and second,not nearly enough has been done to enhancethe administrative capacity of states. Given theknown practical limitations of redistributingincome via spending, the other half of fiscalpolicy cannot be simply laid aside as an in-strument in the war against inequality in themost unequal region in the globe. The impor-tance of undertaking far-reaching administra-tive reform cannot be emphasized enough. AsRichard Bird and Guillermo Perry, two distin-guished fiscal experts, have written:

the secret in raising and sustaining fiscal revenuesoften lies not in the adoption of fancy new policies,but in the more mundane task of establishing a morecredible and effective tax administration (Bird &Perry, 1994, p. 176).


Indeed, fiscal reforms matter little if taxescannot de facto be collected.The larger goal must not however be for-

gotten: if Latin Americans want their govern-ments to have a role that is somewhat moreakin to that in developed countries, currentlevels of tax revenues (as a percentage of GDP)will not do. Recent developments suggest thatsome countries have taken note. Mexico is anotable example. Conscious of the limitationsposed by a public budget that stands at a paltry12% of GDP, Vicente Fox’s government de-vised the most radical and ambitious fiscal re-form in the country’s history, intending toincrease fiscal revenue to $14 billion (about15% of GDP) by the year 2006 (El Pais, 2001).A combination of governmental ineptitude andthe PRI’s obstructionist strategy in Congress,however, led to the proposal’s failure. In acountry of 100 million inhabitants, and aworkforce of 40 million, only 10 million regu-larly pay taxes. This situation mirrors that ofother neighbors. Yet, in spite of all theirbuildup and notoriety, tax reforms currentlyunderway in many countries do not go nearlyfar enough. As tax expert Richard Bird hasnoted, as concerns the developing world, ‘‘re-forms that appear on paper to restructuresubstantially the tax system may have little ef-fect on revenues’’ (Bird & Perry, 1994, p. 4).Latin American experience in this area is vividproof of this statement. That is why bolder andmore ambitious proposals are needed on thisfront. One such proposal was put forth by JohnWilliamson as part of his famous (or infamous)Washington consensus: subjecting interest in-come on assets held abroad (flight capital) totaxation. This would require a shift in taxprinciples in many countries and the negotia-tion of bilateral agreements for sharing tax in-formation with the major destination countries(principally, the United States). Latin Ameri-can governments need to begin taking this andsimilar initiatives much more seriously if theyare to make more progress on fiscal matters. Inattempts to raise revenues, there are two po-tentially taxable areas that have not been seri-ously considered yet (Shome, 1995). They areagriculture and property. These taxes, alongwith an increased emphasis on personal incometax would help countries adopt more progres-sive tax structures and help reclaim fiscal policyas a means of redistribution.Expanding the tax base and increasing gov-

ernment revenues is a challenging and longterm task, but it is not intractable. But, until

the true magnitude of the problem is more ag-gressively voiced within the region and byWashington institutions, it can be expected thatlittle will be done. It is, much like the low do-mestic savings, a structural tax on growth andon better distributional outcomes. Perhaps therelevant but often unstated question remains:when will the region’s upper class deem itworthwhile to pay taxes in their own countries?The short answer is that it shall happen if andwhen a stable and prosperous macroeconomicenvironment is attained. There is certainlysomething of vicious circle in this; no shortcutsare likely.Some may raise a reasonable objection at

this point: isn’t one of the fiscal consequencesof globalization itself a decline in public re-sources? In trying to increase the tax effort, arenot governments swimming against the tide?Many argue that world economic integrationentails both declining resources for publicbudgets and increased demands on those samepublic finances––the double jeopardy of the so-called fiscal squeeze. The liberalization policiesthat underpin globalization, the story goes, leadto a declining public resources via trade liber-alization (resulting in loss of revenue fromtariffs), financial liberalization (loss of revenuefrom financial repression) and investment lib-eralization (posing challenges to tax collection).The increased demands for public spending aresaid to arise out of the increased income un-certainty that global integration brings (Grun-berg, 1998). In the final analysis, to concludethat globalization leads to declining public re-sources, the immediate effects of liberalizationwould have to be compared to the indirect,longer-term contributions to economic growth(and thus enhanced public resources). This isextremely difficult to assess empirically. There-fore, the hypothesis of the fiscal squeeze re-mains only speculative, formulated on the basisof ad hoc evidence.

6. DEFICIENT EDUCATIONAL LEVELSAND INCOME INEQUALITY ASIMPEDIMENTS TO GROWTH

Improving the quality of macroeconomicmanagement and the implementation of struc-tural policies can only take Latin Americaso far. A serious constraint on the region’sgrowth rate is the meager education level ofthe workforce, whose current level of school-ing stands at around 5.3 years on average.


According to world schooling patterns and itslevel of development, the region’s workforcehas two years less of schooling than it should,or stated otherwise, around 40% less schoolingthan other similarly developed areas of theglobe (Londono, 1996). Education works tospur economic growth in two ways: first, byraising the rate of accumulation of humancapital, and second, by increasing the rate ofproductivity growth––via enhancing laborproductivity and the generation of externalitiesfavorable to overall productivity. Of course, theeffects of a more educated populace reach everyconceivable aspect of a society. It has been saidthat if the new global economy had a magicbullet for growth, competitiveness and an im-proved social and political environment, itwould be education.The economic theory underlying the impor-

tance of education is well known. But empiri-cally speaking, just how much can educationcontribute to GDP growth? Economists at theInter-American Development Bank (IDB) havecalculated that if governments’ education effortincreased schooling by one year above currenttrends, potential growth could be raised onepercentage point a year, or about half the es-timated effect of all structural reforms to date!(IADB, 1997). Lora and Barrera (1997) esti-mate that a 2% increase in annual growth rateswould be attained if that enhanced educationaleffort interacted with deepened first-generationreforms. These calculations are sobering andshould give much pause for thought. 8

The costs of inaction are also readily quan-tifiable. The IDB estimates that if current LatinAmerican education policies continue into thefuture, the gap with the rest of the world, nowat two years, will be over three years during thisdecade. The Bank concludes that, under suchconditions, the overall indicators of inequalitywill not change significantly. But path depen-dency is not destiny. Notwithstanding all thetalk about the structural noneconomic condi-tions that allegedly condemn the region topermanent inequality, the possibilities for pol-icy to effect improvements on this score arestaggering:

[If] the governments of the region were to reorganizeeducation systems with a view to closing the educa-tional gap with the rest of the world by the year2020 . . . The average education of the Latin Americanworkforce would then reach nine years of school-ing . . . This means that, combined with macro andstructural policies, the reduction of the coefficients

of inequality would be around 8 or 10 points [in theGini scale], and the extra inequality that Latin Amer-ica displays vis-�aa-vis world patterns would therefore beeliminated (IADB, 1997, p. 76).

To be sure, raising the overall quantity ofeducation means little if quality improvementsdo not go hand in hand. By all accounts, thequality of education in Latin America is low.This common observation is confirmed byempirical evidence from national tests and in-ternational comparisons of student learning(UNESCO, 1995). Most troubling of all is that,according to many experts, the quality of edu-cation has declined (Corbo, 2000). Team afterteam of experts on the issue insists that thequality of education in the continent cannot beimproved without raising the (currently inade-quate) number of hours of instruction. To besure, there are many other dimensions to theproblem. The issue of improving quality ismultifaceted and somewhat complex, but by nomeans obscure or mysterious (Cohen, 1999). Asin many areas, Chile became a vanguard ineducational reform. In 1996, Chile announced amajor initiative to address the country’s edu-cational deficiencies with the aim to increaseproductivity, reduce inequality, and augmentinstruction time by one-third, among others.The reform affected no less than 9,000 publicschools and came at a cost of about 3% ofgovernment expenditures (Edwards, 1997).Chile has already made important strides ineducational coverage, its focus now is on rais-ing quality. But even in Chile, there remainenormous unresolved problems in the educa-tion agenda to tackle; furthermore, the re-formist effort has stagnated since the mid-1990sand does not look so promising nowadays.Experience shows that the social forces arrayedagainst policy and administrative reform in theeducational sector are politically formidable.To overcome it will take nothing short of de-cisive, concerted, and sustained efforts on thepart of the political class across the sub-conti-nent.What accounts for Latin America’s unenvi-

able educational record, especially when com-pared to that of other developing regions?Unlike it is sometimes contended, it has little todo with low public expenditures. Expenditureon education stands at 3.7% of GDP, similar toother developing regions. The efficiency of thatexpenditure, however, is appalling. There aretwo other important culprits for the educa-tional deficit: the institutional organization of


the public education sector (insulation fromaccountability on the part of teachers, admin-istrators and managers, lack of autonomy foreducation providers, unempowered consumers,etc.) and the unequal incidence of publicspending (i.e., its regressive nature) (IADB,1997, pp. 129–132). Some timid reforms toaddress a few of these deficiencies have beenlaunched in the 1990s. But the region’s educa-tional landscape remains depressingly familiar:

Misallocation of resources, inefficiencies, and lack ofaccountability are still predominant attributes of theorganizational structure of education in Latin Amer-ica. Parents are still not demanding better perfor-mance from public schools, schools lack capacityand resources to respond to new institutional environ-ments, and clientelistic practices continue to dominatethe decision making in several countries (Burki &Perry, 1998, p. 97).

Behind the impasse often stands a powerfulactor: national teachers’ unions. Almost noserious reform can take place until unions’ ac-quiescence is gained––a formidable task. It isfor this reason that education experts oftenpoint out that rather than increase socialspending, what governments really need to dois to spend more political capital to overcomeunions.Latin America continues to exhibit a poorly

distributed and low-quality human capital.While providing quality and extensive educa-tion to all socioeconomic groups of society is amatter of social justice, the issue of educationdistribution is also one of crucial economicimplications. As Birdsall and Londono (1998,p. 115) have shown, ‘‘the low rate of overallaccumulation (an average of healthy increasesin years of school completed for a small num-ber, and very limited increases for the greatmajority) is due in part to its unequal nature.’’While modest gains have been made in in-creasing average education levels, they have notbeen accompanied by a better distribution ofeducation. This comes with an expensive pricetag. Econometric studies show that the degreeof unevenness in the distribution of educationhas a strong and robust negative effect ongrowth. Latin America’s poor educational dis-tribution is not attributable to the lack of initialaccess to schools, but to high and more rapiddropout rates among the poor. 9 The result isthat school systems are highly stratified and arenot, as is true in other parts of the world, amechanism of social mobility. Rather, they actto perpetuate current socioeconomic structures.

The numbers speak volumes as to the impor-tance of human capital in explaining incomedistribution. Latin America displays a Ginicoefficient that is 15 points above the averagefor the rest of the world. Londono and Szekely(1997) show that differences in human capitalaccount for 10 points in that gap (five due tothe lower level of accumulation and the otherfive to the inequality of human capital). 10

The fiscal policy implication of all the evi-dence to date is thus rather straightforward:additional financial resources for public primaryand secondary schools from outside the educa-tion sector must be found. One is hard-pressedto find another issue area where relativelymodest changes in the distribution of publicexpenditure could have such a far-reachingimpact on economic and social outcomes. Re-ordering priorities in national public budgetsis therefore imperative. Chile has provided apowerful example to neighboring countries byraising its expenditure on education from 4.5%to 7% of GDP during 1994–2000––amountingto $2.2 billion a year, or about one-seventh ofthe total adjusted national budget (Solimano,Aninat, & Birdsall, 2000, p. 124). Brazil’s Ig-nacio ‘‘Lula’’ Da Silva, Peru’s Alejandro Toledoand Ecuador’s Lucio Gutierrez are some amonga new batch of Latin American presidents pur-portedly passionate about the issue of educa-tion. Time will tell whether they actually spendthe necessary political capital on the issue thatit urgently deserves.Yet education, health, poverty, and inequal-

ity are not merely a function of governments’social service budgets. Reordering spendingallocations is of little or no use in the absence ofeffective institutions. Institutions in LatinAmerica more often than not yield obscenelylow returns to society. The diagnosis of insti-tutional failure is easy to make. Malfunctionsinclude: chronic congestion; poor or inadequateinputs; concentration of funding on personnelcosts; politization; corruption; volatility in po-litical priorities; goal multiplicities; monopoly/monopsony control over institutions, etc.(Graham & Naim, 1998). Unfortunately, theprescription to address such ills is anything butstraightforward. On the political front, thereare entrenched vested interests with a stake inmaintaining current institutional structures,and unfortunately, there are serious questionsas to how much political capital governmentsare ready to devote to the issue.The last impediment to growth considered

here is intimately tied to education: colossal


inequality in income distribution. In the sub-continent, the top 10% of income earners ac-count for about 40% of national income, whilethe poorest 30% account for less than 8% oftotal income. As ex-President Fernando H.Cardoso is fond of saying about Brazil, LatinAmerica is not so much poor as it is unjust––that is, unequal in the sharing of income andwealth (IADB, 1998). It is sobering to realizethat if Latin America had an income distribu-tion such as the average observed in countriesat the same level of development poverty levelsin the region would be half of what theyare. Moreover, the nefarious consequences ofincome inequality for building robust, high-quality democracies in the hemisphere areunmistakable. The worsening regional perfor-mance on inequality has sparked increasedacademic interest in the analysis of the phe-nomenon in recent years. But policy has yet toaccord it the relevance that it deserves. In ad-dition to the already acknowledged benefitsassociated with relative income equality (socialcohesiveness, higher quality of democraticgovernance) we now know from recent eco-nomic research that, ceteris paribus, the moreegalitarian a society, the better its growth re-cord and growth potential. 11 We also knowthat the 1990s and its attendant liberalizationpolicies have not stopped the trend toward amore skewed distribution of income in the re-gion––except for a couple of countries. In lightof these findings, no serious policymaker canever again resort to ‘‘grow first, distributelater’’ arguments. First, high growth by itselfoften does not deliver lower Gini coefficients;second, we now know that there need not betradeoffs between growth-promoting and in-equality-reducing policies––that is, between ef-ficiency and equity (Birdsall & Londono, 1998).Intelligent policies can simultaneously promoteboth aims. Indeed, ‘‘tradeoffs are not inevitablein the development process; many are the out-come of poor policy decisions and inappropri-ate institutional arrangements’’ (Birdsall &Londono, 1998, p. 140). Therefore, there is nogood reason to wait for the Promised Land ofAsian-type GNP growth rates to make head-way on inequality. Recent economic historydemonstrates that, contrary to common wis-dom, significant progress in educational stan-dards can be had in the absence of briskeconomic growth. 12 To tackle income in-equality is to tackle one structural impedimentto an increased trend rate of growth. But thisgoal will not be reached unless serious political

initiatives to reorganize public spending prior-ities and to work on institutional reform aretaken.After the relative success of first-generation

reforms, the dilemma of inequality is only re-cently receiving renewed attention, but it hasbeen neglected for a good part of the last twodecades. Political economist Robert Wade hasdrawn attention to the fact that neither theWorld Bank nor the IMF has devoted signifi-cant resources to studying the phenomenon ofgrowing income disparities. Further, the re-duction of inequality per se has never been anexplicit objective of these institutions (Wade,2001). The unstated premise underlying thisegregious neglect of inequality is that a focuson poverty is sufficient. This is myopic, forthere is a crucial link, as economist NancyBirdsall has noted, that must be more widelyacknowledged and publicized: inequality assuch contributes to low growth, which in turnperpetuates poverty. Various ways have beenposited in which low levels of inequality canstimulate growth: by inducing large increases inthe savings and investments of the poor; byraising rural incomes which limits intersectoralincome gaps and the rent-seeking associatedwith such gaps; by contributing to political andmacroeconomic stability (through variouschannels); by reducing the need for institutions,regulatory and otherwise, that are intended tobenefit the poor but have the effect of reducingoutput and employment, and others. 13

If the rich shareholders that exert controlover these international institutions do not yetdeem it necessary to focus on income dispari-ties, Latin American governments should leadby example. The societal payoff to public in-vestment in human capital will be particularlyhandsome in the coming years, for the regionapproaches a demographic window of oppor-tunity: the combined rates of dependence thatthe working age population will have to sup-port will fall for approximately two decadesbefore rising steadily until after the middle ofthe next decade. Thus,

if policies exploit the opportunity, more work, greatersavings and more education can be generated, andtherefore the mechanisms that perpetuate current in-equality can be attenuated (IADB, 1998, p. 116).

At the dawn of the 1990s, the neoliberal re-forms sweeping the region promised to tacklepoverty via the trickle down effects of robusteconomic growth. A decade later, robust


growth has proven elusive. Some will alwayscontend that first-generation reforms have notgone far enough, and that if they had moregrowth would have been forthcoming. Al-though true, this is virtually a tautology anddoes not in itself provide reassurance that thesereforms would have been enough to attaingrowth on the order required to make a dent onpoverty and inequality. 14 There is, in fact, amuch more important (nonexclusive) factor:much of the answer rests on the little progressmade regarding second-generation reforms.Whatever gains were made in the earlier half ofthe decade, the foundations of that growthproved to rest on shaky grounds, for reasonsalready alluded to. But, as some analysts havepointed out, what is perhaps most remarkableis not the failure of the neoliberal economicprescription to work growth miracles, butrather why growth of 3.2% per annum, modestbut not abysmal, has had almost no discernibleimpact on poverty reduction. To adopt theWorld Bank’s recent language, Latin America’seconomic growth in the 1990s has been growthof ‘‘low quality.’’

7. EMPLOYMENT: THE LINK BETWEENGROWTH, COMPARATIVE

ADVANTAGE, AND INEQUALITY

Vigorous employment creation is a crucialchallenge for Latin American countries to ad-dress for it is a fundamental linkage betweengrowth, comparative advantage and incomedistribution. Official statistics on unemploy-ment in many countries is at unacceptably highlevels and underemployment is rampant. Re-cent studies (De Ferranti, Lederman, Perry, &Maloney, 2001; Gill, Montenegro, & Dome-land, 2002; Weller, 2001) show that LatinAmerican labor markets performed below ex-pectations during the 1990s both in terms offormal employment creation and poverty re-duction. In addition, most countries experi-enced substantial increases in job informalityover the 1990s, as the quality of jobs actuallycreated worsened. 15 (Considering long-termtrends, however, unemployment levels in the1990s were no higher than those of the 1980sor 1970s.) The main reasons for such disap-pointing performance, defying early expect-ations, are rather clear. First and foremost,economic growth was slow and unstable. Sec-ond, most labor-intensive sectors were the leastdynamic, in terms of investment and growth.

Third, in many countries the labor participa-tion rate increased, making the battle againstunemployment more difficult. Finally, the hy-pothesis that the comparative advantage ofLatin America rested on unskilled laborproved mistaken overall, even if this may havebeen true for parts of the region (Stallings &Weller, 2001).In an ever-changing global economy, educa-

tion must prepare workers to adapt to differentjobs involving many different tasks. The rapidpace of change means that education must bean enterprise that evolves in tandem withchanging labor market needs. In the globaleconomy, it is not only nation-states’ tax sys-tems and infrastructure that compete to attractscarce investment, but also their human capital(labor force productivity). 16 In this regard, thegigantic divide between what is actually taughtin Latin American classrooms (from primaryto tertiary levels) and the needs of globalized,ever-changing labor markets is not always fullygrasped (and seldom truly prioritized) by presi-dents or even education ministers.The active promotion of employment was

simply not given prominence as an instrumentof development in the 1990s. The WashingtonConsensus deemed that growth stemming frommacro balances and the more prominent role ofthe market would inevitably translate into jobcreation. But even the brisk regional growth ofthe first half of the 1990s did not translate intosignificant employment creation, discreditingthe simplistic ‘‘trickle-down’’-type argumentsof many economists. Consequently, it is nowmore widely recognized that active productionand labor market policies are needed. Thecurrent Director General of the InternationalLabor Organization (ILO), Chilean JuanSomavia, has denounced standard, ‘‘trickledown’’ globalization development recipes aspatently imprudent and foolish for employmentpromotion. In his opinion,

the recipe Latin America has been handed is to bal-ance her accounts, achieve low inflation, and pursuetrade opening. There is nothing wrong with this pic-ture, particularly in a region with a history of hyperin-flation. But if that is all that is done, we inevitably endup with high unemployment . . . If Latin America istold that its main objective should be the pursuit ofoverall macroeconomic balance (conceived as finan-cial and monetary equilibriums) and not the need toinvest in order to create enterprises and jobs, and thatemployment is a result of those policies, rather thanan explicit objective, then the disappointing result willbe the one we have nowadays (El Pais, 2002).


The director of the ILO has publicly calledfor nothing less than a global political com-mitment to create more ‘‘decent jobs’’ in theregion. Yet this lack of focus upon employ-ment and production-driven policies cannotonly be laid at the door of the IMF. AsSomavia acknowledges, current employmenttroubles were not invented by the IMF orWashington Consensus-type advice. The highlevel of political conflict permeating the in-ternal politics of many individual countries,the lack of sufficient prioritization of employ-ment promotion, the penetration of the stateby corporatist interests, and the absence ofpolicy coordination among countries in theregion contrives against the creation of newand better jobs. The disturbing size of theinformal economy––where one out of everytwo Latin American workers ekes out a liv-ing––is the result of policies that do not takeproduction explicitly into account, least of allin medium and small enterprises. The task ofjob creation has been rightly delegated (intheory, at least) to the private sector, butgovernments can and must offer incentives topromote a model of growth that is morelabor-intensive (i.e., raising the employmentelasticity of growth). If job creation does notbecome something close to a politica de estadowithin Latin American countries, it is doubtfulthat poverty and inequality can be successfullytackled.One of the most constant recommendations

from international financial institutions hasbeen the liberalization (i.e., flexibilization) ofrigid Latin American labor markets. A flexiblelabor market allows economies to adjust moreefficiently to changes in aggregate demand re-sulting from positive or negative shocks, andallows a more broadly based economic growthin that the increase in income is more equitablyshared between capital and labor. Though afew countries have made significant strides inliberalizing their distortive labor markets, ingeneral progress in this area has been rathermodest, not least because the political economyof reform in this area is particularly thorny(Gill et al., 2002). Yet, there is increasing rec-ognition that liberalization has been wronglyconceptualized as something close to a panaceato cure employment problems. Although muchmore needs to be done to enhance the efficiencyof labor markets, it is not clear that ever-moreaggressive deregulation is the simple answer. Inthe view of ECLA’s Stallings and Weller (2001,p. 101),

labor markets are already more flexible than is gener-ally thought and there exist uncertain consequencesfrom introducing radical [liberalizing] reforms in thisarea, both with respect to new net job creation andwith respect to the quality of existing ones.

There is a considerable amount of debate andmuch to learn as to the effects of particularderegulation measures. Modesty must guidepolicy advice in this area.Whatever labor policies are adopted, what is

clear is that employment creation primarilystems from the whole performance of aneconomy. The maintenance of basic macroequilibriums is a sine qua non (though not suf-ficient) condition for the creation of jobs. In thewords of labor economist Rene Cortazar, pre-serving these equilibriums is ‘‘probably themost effective labor policy.’’ If other economicpolicies work at cross purposes with job cre-ation, then pro-employment legislation is likelyto be entirely futile. That is why ‘‘employmentshould be an objective of all economic and socialpolicies, rather than a goal sought only by acluster of very specific governmental laborpolicies (Cortazar, 2002, p. 111). In additionthere is agreement about the fact that there ismuch to be done in order to integrate andweave employment concerns into the fabric ofthe overall economic agenda.

8. CONCLUSION

No one today advocates a return to thelapsed policies of the past, which are clearlyincongruous with the way the internationaleconomy functions today. What it is reckonedhere is that the swinging of the pendulum to-ward globalization-minded policies is divertingattention from domestic policies that continueto be essential for growth and developmentbroadly defined. That is, it is diverting attentionfrom getting ‘‘things right at home.’’ Theobvious is all too often overlooked: virtuousdomestic policies will encourage foreign in-vestment in all of its forms. Many of the basicstasks of economic development have beenpartially laid aside and have been underplayedin the rush to turn economies globalization-friendly. The opportunity costs of not havingdevoted due attention to these issues through-out the 1990s are surely great already––and forthose countries still neglecting domestic vari-ables, the longer the delay the greater the costs.The imperative of shifting much of the agenda


to domestic strategies of development cannotbe overstated.Many long-standing observers of the region

consider the low level of domestic savings to beone of the most serious obstacles to the macro-economic situation in Latin America. Indeed, agood number would predictably rank it as themost important structural macroeconomic de-ficiency. Many other ills stem from it, in what isan unmistakable chain-link of causation: de-pendence on foreign savings renders policysubservient to the requirements of outside in-vestors, which leads to pro-cyclical economicpolicies, sky-high macroeconomic volatility,and closing the vicious circle, reduced privatedomestic savings and long-term investments.The Mexican 1995 debacle showed that LatinAmerican countries are still tempted by capitalsurges in international markets, accepting largeinflows, significant exchange rate appreciations,and growing deficits in current account. A largepool of local savings would obviate the need formassive quantities of foreign ones. Yet, policymeasures to begin to mobilize aggregate home-grown savings have been conspicuously absent.A second domestic issue area that deservesmuch more attention from governments is taxreform. Tax levels remain woefully lowthroughout the region. Without more resourcesat their disposal, the Latin American state willcontinue to be maimed in its ability to under-take crucial public investments, construct thefoundations of a welfare state or effect incomeredistribution (via public spending). A thirdissue emphasized in this essay has been thecurrently deficient intertemporal conduct offiscal policy. It is imperative to reduce the dele-terious effects of economic volatility. Buildingpolitical consensus to put into operation cred-ible countercyclical fiscal policy can do much inthis regard. Fourth, this article has also em-phasized the well-known need to increaseschooling levels and improve the quality ofeducation. Governments pay lip service to thesegoals, but they are often slighted in practice.The average educational attainment of region’slabor force remains well behind other areasaround the world with equivalent levels ofeconomic development. Current expendituresneed to be redistributed toward primary andsecondary levels, where the societal payoff islargest. Most troubling, the quality of educa-tion remains patently deficient. A related issueis that of income inequality. Latin Americanpolicymakers can simply not afford to look toinequality as an afterthought, as they have

done throughout the 1980s and 1990s helped bythe presumed intellectual respectability lent by(simplistic) ‘‘trickle down’’ ideas advancedby many neoliberal economists. Policymakersconcerned with inequality should be heartenedby recent academic output showing that growthand equity do not work at cross purposes. Inturn, the persistence of high income inequality,a drag on growth and poverty reduction, can-not be meaningfully disassociated from thelimited and unequal access to human capital;they are inextricably linked. Therefore, effortsto foster education accumulation, and particu-larly education equality, will pay off hand-somely. A final area were much more politicalcapital needs to be devoted is that of employ-ment. Lying at the intersection of growth,poverty and inequality, employment needs tobe actively promoted, for recent experienceshows that growth is a necessary but not suffi-cient condition to create more and higherquality jobs. Governments can take measuresto change the institutional environment inwhich the private sector employs workers, thusintroducing a more labor-intensive pattern ofgrowth than is currently the case.In a context of scarce political capital and

administrative capabilities, as in Latin Amer-ica, few things are as paramount as establishingthe right policy priorities. What is increasinglybeing said by some reputed independent schol-ars, unconstrained by the politically rare-fied climate of the international financialinstitutions, is that the fancied benefits of eco-nomic openness per se are greatly exaggerated.It must be more widely reckoned that devel-opment begins at home. Some will retort thatthis is no big secret. So what then explains therelentless 1990s exhortation made to develop-ing countries to lessen barriers to trade andcapital while downplaying crucial domesticpolicy areas such as the ones identified here?Moreover, why have developing countriesproved so ready to buy and execute this sim-plistic formula? First, so called stroke-of-the-pen reforms cutting tariffs and lessening capitalmovement barriers are among the easiest toimplement. Second, they are politically less in-trusive than the delicate second-stage gamut ofreforms, and the economic payoffs are pre-sumably rather immediate (falling within thelimited time horizon of politicians). Third, be-hind the advice lie old-fashion First Worldmaterial interests, as some valiant voices havedenounced. 17 The reasons are multifaceted,but these are some important factors. At the


end of the day, most of the processes that plantthe seeds of economic prosperity are endoge-nous in nature: institution building, social co-hesion, the accumulation of human capital,technological upgrading and others. It comescloser to the truth say that development ‘‘comesfrom within,’’ to use the famous structuralistterm, than to assert that development will comefrom making the best use of opportunitiesprovided by international markets––thoughobviously both are true.External forces do not determine a develop-

ing country’s economic future. Even an econ-omist like G.K. Helleiner, a leading academicon the international aspects of development, isforced to admit that ‘‘purely domestic events,constraints and governmental policies domi-nate external influences over longer-term de-

velopment’’ (Helleiner, 1990, p. 4). LatinAmerican public policy orientation today is outof sync with this time-tested reality. The regionhas historically been shackled by big single-issue ideas––be it capital formation, import-substitution, or dependencia. Insofar asneoliberalism puts undue emphasis on liberal-izing trade and capital and downplays otherareas, it also follows this infamous tradition.East Asia pursued its successful developmentpath free from ideological baggage. So shouldLatin America, for globalization as an ap-proach to development is at best a patentlyincomplete roadmap to prosperity. Harvardeconomist Dani Rodrik has put it well: ‘‘stra-tegic use of international trade and capitalflows is part of a development strategy; it doesnot substitute for it (Rodrik, 2000, p. 10).

NOTES

1. See Alain Touraine, ‘‘Cambios en Brazil y Argen-

tina,’’ El Pais, July 6, 2003.

2. Note that what is measured here is not the inequality

and growth performance across three income-level cat-

egories; rather, what is measured is the effect of increased

openness to trade, capital flows, and FDI across three

income brackets. The threshold between low and middle-

income and between middle and high-income economies

is the same adopted by the World Bank.

3. Trade shares (the size of a country’s commerce in

relation to its GDP) and black market exchange rate

premiums are inadequate proxies for trade openness.

Trade shares are negatively correlated with country size.

Black market premiums are not useful variables in a

crosscountry setting, as there can be two countries with

zero black market premiums but very different degrees of

openness, such as the United States and the United

Kingdom. Other measures, such as effective rate of

protection, are more difficult to calculate for a suffi-

ciently number of countries.

4. Incidentally, Oxford scholar John Toye has recently

uncovered from archival research that Singer was the

sole pioneer in the formulation of the declining terms of

trade idea, though Presbisch had a crucial role in

disseminating it throughout the hemisphere and in

accounting for the mechanisms that led to declining

terms of trade.

5. This is not to say that the main development

financial institutions have hit a balance between purely

domestic factors and external sector factors in their

advice. Significantly more emphasis has been given to

the latter.

6. Some have taken this disciplining argument fur-

ther, and argued that globalization is a force for good

insofar as it obliges more open LDC economies to

eschew dubious economic policies and acts as an

invisible hand that, brandishing the stick of potentially

severe punishment, steers countries towards wiser

economic policy stances. This, of course, obviates

something that the 1990s have shown on many an

occasion: the increased fracture between the financial

economy and the real economy. That is, investors and

other financial agents cannot be said to have been

guided in the past solely by a country’s economic

fundamentals and have often acted in ways that depart

from country-specific objective economic analysis.

Countries that did not fully deserve to be punished

have suffered great economic disruption as a conse-

quence. Therefore, the ‘‘disciplining hand of financial

markets’’ hypothesis falls apart as soon as one

acknowledges that this market is by no means self-

regulating, and needs to be governed.

7. ‘‘Structural’’ here means that the policy is adjusted

for the business cycle and fluctuations in the price of its

main export commodity (copper). Taking into consid-

eration a standard price of copper as well as the

country’s potential rate of economic growth, so as to

make revenue projections, policymakers then determine

what level of total public expenditure is in line the 1%

surplus objective.


8. This is not to suggest that more education attain-

ment is a sufficient condition for higher productivity or

growth. An economy that does not perform satisfacto-

rily will often be unable to make the best use of its

human capital––i.e., an increase in an individual’s

productivity is no assurance that he or she will find a

job. Investing in people is a necessary but insufficient

factor for long run growth.

9. The region displays a similar proportion of primary

school attendance as East Asia, and higher rates of

university-educated people, but very small proportion of

the population having attended secondary school.

Needless to say, those that reach university are dispro-

portionately from high socioeconomic backgrounds.

10. Lower physical capital accumulation plays almost

no part, whereas the relative abundance of natural

resources and the extremely high concentration of land

account for the remaining discrepancy––five Gini

points––between the region and the rest of the world.

11. See Persson and Tabellini (1994). They find that an

equality increase of one standard deviation, changing

the share of the middle quintile of the income distribu-

tion by about 3%, increases growth by 0.5%. The reader

is also referred to Alesina and Rodrik (1994), who find

that a reduction of one standard deviation in the Gini

coefficient increases growth by more than one percentage

point.

12. For an excellent analysis of the intricate relation-

ships between social development, growth and poverty

see Jolly and Mehrotra (2000).

13. The general link between inequality and lower

growth has been established in an econometric work

involving a large, worldwide sample of countries, but the

specific channels though which this relationship works

remain to be ascertained.

14. It is estimated that more progress in first-genera-

tion reforms could have increased annual growth in

Latin America by 2.5%. See Corbo (2000).

15. The CEPAL estimates that six out of every 10 new

jobs were created in the informal sector.

16. In an open economy, as most Latin nations

nowadays enjoy, the demand for labor depends on the

stock of capital, technology and other factors that affect

productivity. Given these parameters, employment levels

will depend on the relationship between the cost of labor

and its productivity.

17. Jadgish Bhagwati, among others, has interpreted

IMF advocacy for quick capital account convertibility

as partly a consequence of Wall Street material interests.

See Bhagwati (1998).

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FURTHER READING

Bird, R. M. (1992). Tax reform in Latin America: areview of some recent experiences. Latin AmericanResearch Review, 27(1), 7–36.

Bird, G.& Helwege, A. (Eds.). (1994). Latin America’seconomic future. London: Academic Press.

Birdsall, N., Graham, C., & Sabot, R. (Eds.). (1998).Beyond tradeoffs: market reform and equitable growthin Latin America. Washington, DC: BrookingsInstitution Press.

Birdsall, N., Ross, D., & Sabot, R. (1997). Education,growth and inequality. In N. Birdsall & F. Jaspersen(Eds.), Pathways to growth: comparing East Asia andLatin America. Washington, DC: Inter-AmericanDevelopment Bank.

Bulmer-Thomas, V. (Ed.). (1996). The new economicmodel in Latin America and its impact on incomedistribution and poverty. London: Macmillan.

Edwards, S. (1996). Why are Latin America’s savingsrates so low? an international comparative analysis.Journal of Development Economics, 51(1), 5–44.

Edwards, S. (1998). Openness, productivity and growth:what do we really know? Economic Journal, 108.

Fishlow, A. (1997). Latin America in the XXI century.In L. Emmerij (Ed.), Economic and social develop-ment into the XXI century. Washington, DC: Inter-American Development Bank.

Garrett, G. (2000). The causes of globalization. Com-parative Political Studies, 33(6/7).

Gavin, M., Hausmann, R., Perotti, R., & Talvi, E.(1996). Managing fiscal policy in Latin America:volatility, procyclicality, and limited creditworthi-ness. IDB Working Paper 326, IDB, Washington,DC.

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Stallings, B. (Ed.). (1995). Global change, regionalresponse: The new international context ofdevelopment. Cambridge: Cambridge UniversityPress.

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Woods, N. (Ed.). (2000). The political economy ofglobalization. London: Macmillan Press.

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Globalization as a Development Strategy in Latin America?

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