WASHINGTONThree analysts were recently invited to the U.S. State Department to share some thoughts with the diplomats who serve in the Western Hemisphere. Surprisingly, all of us were mostly in agreement on the impact the current economic crisis will have on the region.
Despite the warnings, Latin Americans were largely unaware of the implications of the U.S. financial meltdown and the recession until only a few weeks ago. They believed that the times when the U.S. sneezed and the region would catch a cold were gone.
What an illusion. A lot of what has helped Latin Americas economies in recent yearsaccess to capital markets, foreign investments, remittances from emigrants, the price of natural resourcesdepends on the health of the global marketplace. Any time the U.S. stock markets lose $30 trillion in a few months10 times Latin Americas gross domestic productthe ripple effects will be felt south of the Rio Grande.
Rather than engage in reform, slash spending and put away some rainy-day money, Latin American governments preserved the status quo and boosted public expenditures by 10 percent annually in matters mostly unrelated to infrastructure, creating alarming new commitments. Except for Chile, which managed the revenue from its copper sales prudently, many of the nations that produce oil (Mexico, Venezuela, Ecuador), minerals (Brazil, Peru) or agricultural commodities (Argentina, Brazil, Uruguay) went on a binge. They will now find themselves starved for cash at a time when they are pledging new forms of government profligacy in the face of the global recession. The temptation to fund it via inflation will be irresistible.
The fact that foreign capital came into the region in recent years (about $100 billion in 2007) led many to believe that reform of the regions pachydermic governments was no longer necessary. But for all of Brazils impressive economic performance, investment levels in that country have been no more than 18 percent of GDP, half the level in Asian countries in their finest hour. In Can Latin America Compete? A book edited by Jerry Haar and John Price, we learn that between 2003 and 2006, Latin Americas economy grew by 54 percent but productivity grew by only 4 percent.
Receiving some foreign capital and using the proceeds of a commodity boom to spend billions of dollars in social programs were not enough for Latin America to make the most of the good years and protect itself against an international downturn. Removing major obstacles to entrepreneurship and innovationrelating to taxation, bureaucracy, labor laws, and political interference with legal institutionsand changing the structure of government spending were needed in order to sustain growth. It didnt happen.
Now the crisis has hit home. Claudio Loser of the Inter-American Dialogue has calculated that total losses for the region already amount to the equivalent of 60 percent of its GDP.
Mexico, whose economy is intertwined with that of the U.S., will suffer, as will Central America. Countries that are dependent on commodities will be severely affected. Brazil, dependent on them for only a third of its exports, is also closely aligned with international financial markets. Many of its companies had invested in credit-related instrumentsthe ones that sparked off the financial messto hedge against currency movements. The Brazilian stock market has lost 50 percent of its value already. Other countries whose exports have diversified, such as Peru, will be impacted because of the drop in international demand.
There is an upside. Caracas will find it tough to fund its Bolivarian farce around the continent. Hugo Chavezs budget is based on the presumption that the average cost of oil will be $90 a barrel; the current price of Venezuelas thick crude is below $35. The other good news is that the populist model supported by the Argentine government, a tragicomic study in self-destruction, will be seen for what it really is. Finally, relations between the vegetarian (social-democratic) left and the carnivorous (revolutionary) left will be very strained, which will further isolate the latter. Venezuela and Ecuadortwo carnivoreshave declared political war on Brazila vegetarianby refusing to pay their debts with the Brazilian development bank, a major source of funding for infrastructure projects in South America.
The danger for Latin America is not so much revolution but irrelevance. It has been said that the U.S. has not been paying enough attention to the region. The real story is that Latin Americans were not paying enough attention to the United States.