ECONOMIC POLICY and the TRANSITION to DEMOCRACY Economic Policy and the Transition to Democracy the Latin American Experience

ECONOMIC POLICY AND THE TRANSITION TO DEMOCRACY Economic Policy and the Transition to Democracy The Latin American Experience

Edited by

Juan Antonio Morales Professor of Economics and Econometrics Catholic University of Bolivia

and

Gary McMahon Senior Specialist International Development Research Centre Ottawa, Canada

INTERNATIONAL DEVELOPMENT RESEARCH CENTRE Editorial matter and selection © Juan Antonio Morales and Gary McMahon 1996 Chapters 1-7 © Macmillan Press Ltd. 1996

Published in the United Kingdom in 1996 by Macmillan Press Ltd.

Published in Canada in 1996 by the International Development Research Centre PO Box 8500 Ottawa, Canada KIG 3H9

Canadian Cataloguing in Publication Data Morales J. A. McMahon, G.

Economic policy and the transition to democracy : the Latin American experience, Ottawa, ON, IDRC ; Houndmills, Macmillan Press Ltd 1996. 000p.: ill. /Economic policy/,/democratization/./economic stabilization/,/economic reform/,/economic administration/,/Latin America/-/ Bol iv i a/,/Argentina/, /Brazil/,/Uruguay/,/Paraguay/,/Chile/,/case studies/. UDC: 338.2:321.7(8)

ISBN 0-88936-747-7 (hc) ISBN 0-88936-754--X (pb) I would like to dedicate this book to all of my friends in South America who have kept up the intellectual battle through the bad as well as the good years and, incidentally, have also made my job so much more enjoyable. GARY MCMAHON

Contents

List of Tables x Notes on the Contributors xii Foreword xiv List of Abbreviations xv Map of Latin America xvii

1 Economic Policy after the Transition to Democracy: A Synthesis Juan Antonio Morales 1

1.1 Introduction 1 1.2 The inheritance of the military governments 3 1.3 The first governments of the democratic transition 6 1.4 Stabilisation programmes during the transition 10 1.5 Failed stabilisations and second-round successes 13 1.6 The economic reforms 18 1.7 The interactions between politics and economics during the transition 20 1.8 Final comments 27

2 Economic Policy in Bolivia after the Transition to Democracy Juan Antonio Morales 30 2.1 Introduction 30 2.2 The return to democracy and the difficulties faced by the government 31 2.3 Efficient administrations and the new economic policy 34 2.4 Public sector reform 38 2.5 Prospects of the NEP 43 2.6 Final comments 46

vii viii Contents

3 Democratic Restoration and Economic Policy: Argentina, 1984-91 Mario Damill and Roberto Frenkel 49

3.1 Introduction 49 3.2 Background 53 3.3 The problems of economic adjustment in a democracy 62 3.4 Final considerations 92 Appendix 3.1 96

4 An Economist's Political View of Democratisation in Brazil Edward J. Amadeo 112 4.1 Introduction 112 4.2 The economic and social facts 115 4.3 Societal and political aspects of democratisation 124 4.4 Conclusions 133

5 Democratic Restoration and Economic Policy: Uruguay 1985-89 Luis Macadar 137

5.1 Introduction 137 5.2 Major trends 137 5.3 The legacy of the crisis 139 5.4 The economic policy of the constitutional government 141 5.5 Recovery and adjustment 149 5.6 Consolidation of external sector liberalisation 151 5.7 Domestic disequilibria 153 5.8 Changes in income and factor distribution 157 5.9 Summary and conclusions 161

6 Economic Policy and the Transition to Democracy in Paraguay Melissa H. Birch 166

6.1 Introduction 166 6.2 The economic legacy of the Stroessner regime 167 6.3 The Paraguayan economy in transition 172 6.4 Economic policy and the transition to democracy 174 6.5 The unfinished agenda: institutional modernisation and economic development 194 Contents ix

7 Chile in Transition: Economic and Political Strategies Oscar Munoz Goma and Carmen Celedon 191 7.1 Introduction 191 7.2 Major strategy options for the transition to democracy 191 7.3 The social market economy and the private sector 195 7.4 Macroeconomic policy 204 7.5 Democracy and governability: themes for the 1990s 212

Bibliography 223 Index 231

ix List of Tables

2.1 Consolidated non-financial public sector operations, 1980-90 39 2.2 Evolution of public sector social expenditure, 1980-8 40 2.3 Employment in the public sector, 1980-9 42 2.4 Private and public gross fixed capital formation, 1980-90 43 3.1 Inflation, growth and balance of current transactions with the rest of the world, 1960-91 96 3.2 National income, savings and investment 97 3.3 External savings, fiscal deficit and private surplus 97 3.4 Real exchange rate and real wages 98 3.5 Total external and public debt 98 3.6 External debt as percentage of GDP and of exports 99 3.7 Public sector savings, investment and financing 99 3.8 Monetary assets in the hands of the public 100 3.9 Composition of GDP by type of activity 100 3.10 Balance of payments 101 3.11 Prices of commercial exchange 101 3.12 Real rates of interest 102 3.13 Employment by sector 102 3.14 Unemployment and underemployment 103 3.15 Estimates of functional distribution of income 103 3.16 Evolution of the tariff structure 104 3.17 Public bidding for the National Telecommunications Enterprise - ENTEL 105 3.18 Revenue from the privatisation of state-owned companies and public bids for petroleum exploitation areas 105 4.1 National accounts 116 4.2 Interest rate, inflation and relative prices 117 4.3 Social and economic indicators: Brazil compared with middle- and high-income countries 120 4.4 Income distribution and enrolment in education, 1982 123 4.5 Distribution of public expenditure on education according to educational and governmental level, 1988 123

x List of Tables xi

4.6 Percentage of failures, repeaters and graduates by type of school, 1987 123 5.1 Uruguay: main macroeconomic indicators 142 5.2 Uruguay: main external sector indicators 144 5.3 Uruguay: main financial indicators 154 5.4 Transfer of revenues 159 6.1 Real rates of economic growth 168 6.2 Changes in real wages 169 6.3 Structure of the Paraguayan economy 169 6.4 Paraguay: external debt 171 6.5 Central government expenditure by ministry 176 6.6 Macroeconomic indicators, 1983-8 177 6.7 Real wages under democracy 181 7.1 Chile: evolution of the principal macroeconomic indicators 206 7.2 Chile: balance of payments, 1989-92 211 7.3 Chile: foreign debt by debtor at the end of the year and indebtedness indicators 213 Notes on the Contributors

Edward J. Amadeo received his PhD in economics at Harvard Uni- versity in 1986. He is the author of Keynes's Principle of Effective Demand, Keynes's Third Alternative, with Amitava K. Dutt, and several published articles.

Melissa H. Birch is Associate Professor at the Darden School of Business Administration at the University of Virginia. She received a Fulbright award to conduct research on public enterprise and economic development in Paraguay and is the author of several articles on the Para- guayan economy. She travels frequently to Latin America, especially the Southern Cone, for research and consulting on public enterprise management and privatisation.

Carmen Celedon was born in Santiago, Chile in 1955. She received her undergraduate and master's degree in economics from the Univer- sity of Chile. She has been a research economist at the Centre for Latin American Economic Research (CIEPLAN) since 1989 and as- sistant to the executive director since 1992. Her main fields of special- isation are international economics, macroeconomics, and public sector reform and modernisation.

Mario Damill is Professor of Macroeconomics at the School of Econ- omics of the Universidad de Buenos Aires and at the Institute for Econ- omic and Social Development (IDES).

Roberto Frenkel took part in the Austral Plan, the most important stabilisation attempt in Argentina during 1980s, as the head of the Advisors' Committee of the Minstry of Economy. At present he is Director of the Graduate Program on Capital Markets at Universidad de Buenos Aires, and Director of the Graduate Program in Economics at the Institute for Economic and Social Development (IDES).

Luis Macadar has been Investment and Project Expert at the government agency (CIDE) that prepared the First National Plan for Econ- omic and Social Development in Uruguay in 1965. From 1967, he was Researcher at the Institute of Economics of the University. In 1972 he

xii Notes on the Contributors xiii was appointed Professor of Investment Project Evaluation. In 1975, together with other Uruguayan Economists, he founded the Centro de Investigaciones Economica (CINVE-Uruguay), where he conducted several academic research works, with support from foreign donor agencies (Ford Foundation, IDRC, SAREC), and he was Director of the Center until 1988. He has also been a consultant for several international agencies (UN, IDB, World Bank, ECLA, ALADI, INTAL), and his writing includes books and articles about Uruguay in the field of economic policy, industry and trade.

Juan Antonio Morales is Professor of Economics and Econometrics at the Catholic University of Bolivia. He has published widely stabilisation and structural adjustment in Latin America. Currently he is on the Board of Directors of the Central Bank of Bolivia.

Gary McMahon is Senior Specialist with the International Develop- ment Research Centre (IDRC) of Canada, where he has worked since 1989. Prior to this appointment he was Professor of Economics at Laurentian University, Sudbury, Canada, for eight years. Before joining the IDRC he published a number of articles in the area of comput- able general equilibrium models and their application to the problems of developing countries. In recent years he has concentrated on macroeconomic and stabilisation issues, especially with respect to Latin America. His more recent work includes articles on heterodox stabilisation policies, the economic lessons for Eastern Europe from Latin America, and the interaction between fiscal and macroeconomic policies. He is the editor of Lessons in Economic Policy for Eastern European from Latin America and a co-editor of Fiscal Reform and Structural Change.

Oscar Munoz Goma obtained an MA in economics from the Universidad de Chile and a PhD from Yale University. He has taught economics at Universidad de Chile, Universidad Catolica and Universidad Diego Portales. He has also been Visiting Professor at several United States universities. Since 1976 he has been researching at CIEPLAN and acted as Executive Director during the period 1979-81. He has written several articles and books on economic development, industrialisation, income distribution and Chilean economic history. Some of his most recent publications are Chile y industrialization pasado, crisis y opciones, and Estado, desarrollo y equidad: algunas preguntas pendients. Foreword

This book is the result of a long process initiated by Luis Macadar in early 1991, when he approached the IDRC with the idea of a manuscript on economic policy during the transition to democracy in Uruguay. After discussions with a number of people we came to the conclusion that there would be great interest in both writing and reading a number of such manuscripts on the various countries in Latin America that had undergone this process in the 1980s and early 1990s. We approached economists in six countries, including Uruguay, to see whether they were interested in writing the papers. Thus we were able to obtain papers on Argentina, Bolivia, Brazil, Chile, Paraguay and Uruguay. These were all written by nationals, except for that on Paraguay, where Melissa Birch, a leading expert on Paraguay, undertook the project. The papers were written over a period of nearly three years, partly due to other commitments but mostly for historical reasons - that is, in Chile and Paraguay events were just beginning to unfold. In the end we decided to abandon the idea of a manuscript series but rather to publish the papers together as a book with a synthesis by Juan Antonio Morales, the Bolivian author and co-editor of this book. We also let the authors choose the extent to which they would focus on economic policy versus political economy. As the reader will see, and as Mo- rales explains in the synthesis chapter, the various authors put quite different weights on these two basic elements of the discussion. While these weights undoubtedly reflect some of the training and interest of the authors, we think that it is fair to say that they mostly reflect the particular nature of the different transitions. In the end we believe that the project was greatly enriched by the variety of approaches taken towards a common problem; that is, the management of economic policy in the transition to democracy. We would like to finish by thanking all the authors for their contributions, Oscar Munoz for his help in organising the translations and Carmen Du Bois for her help in preparing the final manuscript. Fi- nally, we would like to thank the International Development Research Centre of Canada for funding this project.

GARY MCMAHON JUAN ANTONIO MORALES

xiV List of Abbreviations

ADN Nationalist Democratic Action AEN Alianza Encuentro Nacional ANDE Administracion Nacional de Electricidad ARENA Alianza Renovadora Nacional AYEE Agua y Energia Electrica BANADE Banco Nacional de Desarrollo BB Bunge and Born BCRA Banco Central de Reserva de Argentina BNDES Banco Nacional de Desenvolvimento Social y Economico BONEX External bonds CEDES Centro de Estudios de Estado y Sociedad CEPAL Comision Economica para America Latina CEPS Bolivian Confederation of Private Entrepreneurs CGT Confederacion General del Trabajo COB Central Obrera Boliviana COMIBOL Corporacion Minera de Bolivia CONARDO Concertacion Nacional Programatica CPI Consumer price index CPT Confederacion Paraguaya de Trabajadores CRD Regional Development Corporation EAP Economically active population ECLAC Economic Commission for Latin America and the Caribbean EIU Economist Intelligence Unit ENTEL Telecommunications Enterprise FEPRINCO Federacion de Produccion, Industria, y Comercio FOSIS Fondo de Solidaridad e Inversion Social FSE Emergency Social Fund GBA Gran Buenos Aires GDP Gross domestic product GNP Gross national product IBASE Instituto Brasileiro de Analises Sociais e Economicas IBR Institute de Bienestar Rural IDB Inter-American Development Bank IDIAL Institute Paraguayo para la Integracion de America Latina

xv xvi List of Abbreviations

IDRC International Development Research Centre IFI International financial institution ILO International Labour Organization IMF International Monetary Fund INDEC Instituto National de Estadistica y Censos ISI Import substitution industrialisation MDB Movimiento Democratico Brasileiro MERCOSUR Southern Cone Common Market MIR Revolutionary Left-Wing Movement MNR National Revolutionary Movement MOPOCO Movimiento Popular Colorado NEP New Economic Policy OECD Organization for Economic Cooperation and Development OSN Obras Sanitarias de la Nacibn PLRA Partido Liberal Radical Autentico PPD Party for the Democracy PSH Permanent Survey on Households PT Partido de los Trabajadores RGNP Real gross national product SEGBA Servicios Electricos del Gran Buenos Aires SLAS Society for Latin American Studies SP Socialist Party UDAPE Unidad de Analisis de Politicas Economicas UDI Independent Democratic Union UDP Unidad Democratica Popular UIP Union of Paraguayan Industries UK United Kingdon UNIDO United Nations Organization for Industrial Development US United States VAT Value added tax YPFB Yacimientos Petrolfferos Bolivianos Map of Latin America

0 DOMINICAN REPUBLIC Santo Domingo AIC' VHAITI - 'ngam rT-' PUERTO RICO IEL-Imolpen._ Ponao- Gua mal °a DOMINICA GUATEMALA ST. LUCIA San Salvador 'BARBADOS EL SALVADOR TRINIDAD AND TOBAGO Managua Potl-,f Spain COSTA GUYANA RICA orgetown--b. FRENCH GUIANA cayenne

South

Atlantic

Ocean

xvii 1 Economic Policy after the Transition to Democracy: A Synthesis* Juan Antonio Morales

1. 1 INTRODUCTION

The 1980s brought enormous changes, both political and economic, to almost all the countries of Latin America. In the political sphere the most important change was the transition to democracy after many years of military dictatorship in a large number of countries. In the economic field we saw - after a severe crisis - reduced inflation, liberalised markets, the start of privatisation and, more generally, measures aimed at radically reducing the participation of the state in the economy. These large economic reforms were accompanied by stabilisation programmes that, superficially, appeared to have more limited objectives. These changes cannot be understood without reference to the political context in which they were undertaken. Accordingly the chapters in this book centre on the interaction between politics, in a broad sense, and economic policy, more narrowly defined. The book contains six case studies - Argentina, Bolivia, Brazil, Chile, Paraguay and Uruguay - all of which try to answer the following questions: What were the main problems with respect to governance during the transition? To what extend did political factors during the transition affect the economy? Why were the economic reforms so radical, going far beyond what was required for stabilisation purposes? With how much conviction have the countries adopted the liberal economic model and what is the probability of reversal? The economic and political transformation of the six countries have common characteristics, which will be emphasised in this introductory chapter. One must, however, take into account the different qualities of each experience, also keeping in mind their distinct levels of economic development and political histories. In Chile, the restoration of democracy took place in 1990 when the

1 2 Economic Policy after Transition to Democracy country was already demonstrating a strong economic performance. In Uruguay in 1985 the economic situation was also relatively healthy, at least in comparison with the recessionary years of 1983 and 1984. Likewise the Paraguayan transition, which began in 1989 in an unexpected and abrupt fashion, did not take place in the middle of an economic crisis. The transition made clear the structural problems and the shortcomings of the Stroessner model of economic development, but the macroeconomic disequilibria were managable without resorting to extraordinary measures. In contrast, the return to democracy of Bolivia in 1982, Argentina in 1983 and Brazil in 1985 occurred at the height of a severe deterioration of their respective economies. In each of these three countries, the transition to a democratic regime coincided with the emergence of very significant macroeconomic disequilibria. The first democratic governments of Argentina, Bolivia and Brazil all failed in their attempts to moderate inflation and put an end to stagnation. In the first two countries it was left to subsequent governments to contain inflation and begin the structural reforms. Brazil is still searching for a solution to the problem of inflation. It is not easy to define the limits of the transition. The studies in this volume have a broad coverage as they consider all the governments involved in democratic restoration, albeit with more emphasis in the earlier ones. Thus, in the case of Argentina the authors discuss the policies of Presidents Raul Alfonsin and Carlos Menem. For Bo- livia, the governments of Hernan Sites Zuazo, Victor Paz Estenssoro and Jaime Paz Zamora are considered. The chapter on Brazil looks at the governments of Jose Sarney and Fernando Collor de Melo, while that on Uruguay focuses mostly on the first government of Julio Maria Sanguinetti. Similarly, for Chile the discussion is limited to the first democratic government of President Patricio Aylwin. Subsequent governments in Bolivia, Argentina and Brazil represented a consolidation of democracy. The terms of office of these `second transition' governments, as we will see, were as full of significant events as were the transitions from authoritarian regimes to democracy.' Although the first civilian government of Paraguay took power in August 1993, headed by President Carlos Wasmosy, the author of Chapter 6 considers as part of the transition to democracy the government of General Andres Rodriguez, who displaced via a coup d'etat the government of General Alfredo Stroessner, who had governed for 35 years. Rodriguez called an election immediately after the coup and was elected president. Despite his questionable legitimacy, from the Juan Antonio Morales 3 beginning he gave clear signs that he would distance himself from the authoritarian past. For purposes of analysis we will make a distinction between planned democratic transitions and those imposed by circumstances.2 In planned transitions some preparatory work had been undertaken by the military government. One example of this was the formation of transition teams. While the most clear cases are those of Chile and Uruguay, we also include Paraguay in this category as its military government made very clear indications of a political opening up. Among the imposed transitions one finds Argentina and Bolivia, where exogenous events produced a rapid move towards democracy. Brazil also fits into this category as popular pressure in 1984 precipitated a return to democracy somewhat earlier than the date planned by the authoritarian regime.' This introductory chapter is organised along the three broad themes tackled by the studies in this volume, starting with the initial political and economic conditions faced by the democratic governments. At the same time we analyse the perceptions held by the various governments about the nature of the economic crises they inherited. Then we will discuss the liberal economic reforms that have taken place and their links with the control of inflation. In the last section we turn our attention to the strategic interactions of the distinct social actors and the economic policy makers.

1.2 THE INHERITANCE OF THE MILITARY GOVERNMENTS

The six countries had to endure severe dictatorships during most of the 1970s and several years of the 1980s. The similarity between the political models does not, however, extend to the economic models that were adopted. In Argentina, Chile and Uruguay the military governments initiated the liberalisation of the external sector with different degrees of intensity, with regard to both the current and capital accounts of the balance of payments. The financial opening up of Uru- guay, which began in 1978, was the most ambitious of the three. In contrast with these experiments in external sector liberalisation, the military governments of Brazil, Bolivia and to some extent Paraguay accentuated the characteristics of the state-led development model they had followed since the mid-1950s. It is necessary to emphasise that the policies of external sector liberalisation in Chile and Uruguay lasted much longer than the governments that introduced them. An important question is why these reforms, 4 Economic Policy after Transition to Democracy instituted by authoritarian regimes and contrary to the majority of the prevailing public opinion when they were introduced, were retained after the return to democracy? Similarly, why did the same not occur in Argentina, where the first democratic government did not preserve the reforms? A tentative answer to these questions is that in the case of the Chi- lean and Uruguayan reforms the commitment of the governments to maintain them, despite possible ideological differences, appeared credible to the public, even if they were slow in bearing fruit. In Argen- tina the macroeconomic inconsistencies, especially those generated by the fiscal and exchange rate situations, destroyed the credibility of these reforms.' In Chapter 3 Damill and Frenkel go even further when they say that the central cause for the extreme deterioration of the two basic macroeconomic disequilibria, the current account and fiscal deficits, resided in the repercussions of the dramatic failure of the financial and external sector liberalisation experiments of the military government in 1978. During the military era all six countries borrowed heavily from international commercial banks, and with this financing almost all the countries attained high levels of economic growth. Very importantly, this strategy of growth with debt, as Amadeo emphasises in Chapter 4 on Brazil, appeared to benefit all social groups but failed to reduce overall inequality. Although the number of persons in poverty fell, the military governments paid little attention to the question of income distribution. This was influenced more by the restrictive wage policies of the epoch, as well as by a regressive structure of social expenditure. The first effects of the debt crisis of 1982 were felt in the current account of the balance of payments. It needs to be emphasised that the rapid increase in the current account deficit was not due to a large jump in domestic absorption but to the unexpected and substantial increase in interest rates charged on the external debt. The implications of the change in the origin of the current account deficit were not perceived correctly, which resulted in the incorrect application of traditional adjustment policies. The failure of these policies strongly reduced the governance capabilities of the military regimes, which also had to confront political problems caused by an increasing social demand for democracy. The debt `shock' forced the governments to make massive internal and external adjustments. On the external front the economies had to build up large trade surpluses, which they did, at least transitorily, by way of massive devaluations, quantitative restrictions on imports and Juan Antonio Morales 5 enormous contractions of aggregate demand. The large nominal devaluations resulted in significant, if transitory, real devaluations. However, in this effort to maintain a high real exchange rate, the governments destabilised the precarious equilibrium between wages and domestic prices, and thus the fragile social equilibria. The internal adjustment required measures almost as dramatic as the external one. Except in Bolivia and Chile, and to a lesser degree Para- guay, the debt service demanded not only an external transfer of resources but also a large internal transfer from the private sector to the government. The debt crisis strongly upset the financial systems, especially the banking sector, of Argentina, Chile and Uruguay, although the situation was less serious in the other three countries. This financial instability had important effects on macroeconomic stability. In order to rescue the banks and highly indebted firms, the governments had to intervene in the financial markets, producing enormous transfers of income and wealth from creditors to debtors. Perhaps more important were the similar transfers between the private and public sectors, to the detriment of the latter. The gravity of the financial crisis in Chile, which was similar to that suffered by Argentina and Uruguay, cast doubt on the market model that had begun in 1973, at least in its most extreme forms. The crisis also reinforced popular discontent with the dictatorship's abuse of civil liberty. Nevertheless, Pinochet's government reacted rapidly and efficiently to the new international context and its internal repercussions. When its term ended it handed on to the democratic government an economy in the middle of sustained expansion. This represented an essential difference from imposed transitions. In the 1970s inflation was already a serious problem in four of the countries of the study: Argentina, Brazil, Chile and Uruguay. Argen- tina, Chile and Uruguay all followed a similar anti-inflation policy at the end of that decade, having established a system of preannounced devaluations (the `tablita') in order to guide inflationary expectations. As the rate of inflation did not decrease (or at least increased more slowly than expected) the tablita and, more generally, the use of the exchange rate as a nominal anchor resulted in very significant overvaluations of the real exchange rate. The trade deficits caused by these overvaluations were financed with capital flows induced by the high domestic rates of interest. The reversal of these same flows after the debt crisis of 1982 aggravated a situation that was already extremely difficult. Thus the external adjustment 6 Economic Policy after Transition to Democracy had to be larger than would have been necessary in order to correct the overvaluation of the currency. The destabilisation of the Bolivian economy by the debt crisis occurred for different reasons than in the other five countries. In Bolivia the problems of external indebtedness translated immediately into a severe fiscal crisis.' The huge increase in external interest payments increased fiscal expenditure as the government could not efficiently reduce other expenditures or increase tax revenues. More importantly, external credit immediately ceased to be available as a means of financing the fiscal deficit. The military government of 1982, authoritarian but paradoxically weak due to its lack of legitimacy, opted for the easy solution of financing the deficit by printing more money. The real reason for the transfer of the government to civilian hands in 1982 was due to the very high inflation caused by all this extra money being circulated. One can conclude that, in almost all the countries studied in this book (except Paraguay), the serious crisis at the beginning of the 1980s had at its roots the fragility of the fiscal accounts and the financial system, weaknesses that had accumulated over decades. The fiscal disequilibriurn was greatly to affect the capacity for state regulation of the various economies during the 1980s. In addition, the financial fragility constituted a recurring danger for macroeconomic stability, at least in the first half of the decade. The external debt crisis of 1982 was only the detonator of a large explosion containing a mix of different crises.

1.3 THE FIRST GOVERNMENTS OF THE DEMOCRATIC TRANSITION

The planned democratic transitions took place under relatively benign economic conditions. In contrast, the `imposed' transitions occurred when the economic crises, at both domestic and international levels, were entering their most severe phase. This general observation provides a point of departure for our analysis. The Uruguayan and Paraguayan governments were able to contain their respective crises with a large effort, but without the need to take extraordinary measures. In Chile, the problem facing the new democratic government was not how to avert an economic crisis but how to maintain and strengthen the stability and growth attained in the last years of the military government, as well as how to resolve the prob- Juan Antonio Morales 7 lem of income distribution. Resolution of the distributive problem was greatly facilitated, however, by a very vigorous economic expansion, which helped to alleviate any confrontations. Sides Zuazo in Bolivia, Alfonsin in Argentina and Sarney in Brazil all completely underestimated the extent of the economic crisis as well as the political opposition (although less in Brazil) they would have to confront. On the one hand, with what could only be called wishful thinking, they overestimated the margins of action for economic policy. Steeped in the euphoria of strong initial support, they ignored the demands of the economic situation and either embarked on very risky stabilisation plans or very inopportune expansionist policies. To the incorrect perception of the nature of the crisis one can also add that these governments had a poor appreciation of the correlation between political and social forces. Bolivia demonstrates the most clear- cut case of this statement. In the 18 years of military rule that preceded the democratic transition, the social demography of the country had changed immensely, due principally to an increase in the size of the middle class, which showed, moreover, that they were willing and able to strengthen their political power. Sides Zuazo badly miscalculated the power held by the middle classes. Thus, for example, in his first attempt at stabilisation he included a measure to dedollarise contracts.' Irrespective of the technical merits of the measure, which had been tried in various other countries with differing results, the reaction of the middles classes was extremely harsh. Thus the Zuazo government provided the opposition with a powerful instrument around which to rally its forces. The political weakness of the government began with this measure, which was introduced only a few weeks after taking office. In all the countries of the study there were sharp distributive conflicts, but this was especially the case in Brazil. In Chapter 4 Amadeo emphasises the difficulties caused by clientelism and state corporatism, which was deeply ingrained in Brazilian politics. Powerful interest groups were already present during the years of the military governments. With democratisation, many organised urban-based groups, previously excluded, became important actors in the dispute for public resources and benefits from the state. The enlarged distributive demands ultimately found formal expression in the broad social rights that were included in the Constitution of 1988. In a democratic society the process of broadening the spectrum of social actors should culminate with universal demands. However the simultaneity between the democratic opening and the deteriorating 8 Economic Policy after Transition to Democracy

economic outlook led to a profound conflict between clientelistic and universal demands for public resources. The renewal of union activity was another factor that significantly affected the design of economic policy during the democratic transition in Argentina, Brazil, Bolivia and, to a lesser extent, Uruguay. Generally speaking, workers' movements had been tightly controlled by the military governments and the unions often had to work in a clandestine manner.7 The return of union rights was an integral part of the return to democracy. Once the unions had restored their former power, labour conflicts were frequent, and at times very aggressive. After the failure of their initial economic policies, Zuazo, Alfonsin and Sarney tried to establish comprehensive social pacts. However, as Torre (1993) notes quite correctly, it is difficult to put together a social pact during a transition period (especially an unexpected transition) as this implies the freezing of existing power relationships. The incentives are all there for non-cooperative strategies. Torre also notes that during a transition one can also expect to see an increase in labour conflicts that have less to do with economic goals than the political goals that unions have set for themselves. Naturally Torre's conclusions can be extended to other political and social actors, in particular business associations. The Chilean and Uruguayan transition experiences contrast greatly with those of Argentina, Bolivia and Brazil. In Uruguay the dialogue between the different social sectors was reestablished, and during the entire democratic period the search for consensus had dominated. Con- gress was able to work effectively immediately after the transition to democracy, in contrast with the imposed transitions where legislative power was relegated. The objectives of the distinct social sectors were subordinate to the more general one of maintaining democracy, and several social groups were willing to accept temporary drops in their income levels. For its part the political agenda of the democratic Chi- lean government, which included the preservation of the economic attainments of the military government although with more emphasis on distributive aspects, naturally created a favourable climate for consensus building. The Paraguay situation fell in between the two cases above. At the beginning of the transition period the social movements acted very carefully in order not to destabilise the transition government. However, in the second part of the Rodriguez government's term of office several business organisations worked successfully to block a number of reform proposals, so the government was unable to complete its agenda. Juan Antonio Morales 9

The governments, like the international financial institutions (IFIs), underestimated the duration and magnitude of the external debt crisis. Between 1982 and 1985 the various countries, advised and even pres- sured by the IFIs, made net external resource transfers that were probably the highest in their histories. The governments were slow to perceive - doing so only when the international and domestic settings had already changed - that these income transfers were the main source of instability. In the first half of the 1980s the military governments of Argentina and Brazil made various attempts at stabilisation. The most serious of these involved orthodox measures, of the type recommended by the IMF, that placed most of the burden on fiscal adjustment and little importance on incomes policies. The failure of these plans set off a very vigorous debate about the causes of the inflation. It was no longer accepted without discussion that inflation was simply a monetary phenomenon caused by uncontrolled fiscal deficits. At least in the countries that had developed methods of living with inflation, alternative explanations were sought. It was argued that one could find the causes of inflation in the automatic indexation of contracts, especially labour ones, in the shortening of the terms of financial operations, in asymmetric price adjustments and in accommodating monetary policy. Due to the strong inertia of this type of inflation, restrictive monetary policy would not have the conventional disinflationary effects, except at the cost of a very long and deep recession. In 1984 the spectre of hyperinflation appeared in Argentina and hyperinflation was declared in Bolivia. In Argentina (as well as Bra- zil) the predominant perception was that orthodox IMF programmes, at least the standard versions of the early 1980s, were inefficient in fighting inflation. In Bolivia the reverse was true - the orthodox view- point was gaining acceptance by both economists and the general public, and it was thought that if orthodox programmes failed, it was not because they were wrong, but because they were not applied with sufficient strength. Despite the failure of the first orthodox plans, substitutes were not easily found." As the initial conditions were different in the countries with planned transitions, the behaviour of the governments was also different. Plans tended to be both imaginative and cautious. In Chapter 5 Macadar re- minds us that in Uruguay the new government was faced with a semiparalysed economy, and the immediate challenge consisted of restoring the confidence of the economic agents as well reviving production in a very unsettled international climate. The initial results were surprisingly 10 Economic Policy after Transition to Democracy good, although it later became obvious that the crisis had not been completely overcome. In Chile, the military government had completed the work of stabilisation, which was successfully maintained by the democratic government, although with some difficulties at the beginning, as we shall see later. In Paraguay, the Rodriguez government initially implemented some bold and sweeping measures, especially in the financial area. Other announced reforms were not implemented.

1.4 STABILISATION PROGRAMMES DURING THE TRANSITION

Shock Programmes

In June 1985 in Argentina the Alfonsin government announced the Austral Plan, which was presented to the public as a heterodox shock programme with the following components: (1) monetary reform, including a new currency, the austral; (2) fiscal correction measures; (3) the elimination of indexation mechanisms and the reconversion of financial contracts in order to make them consistent with low inflation; and (4) the freezing of prices and salaries in order to coordinate the decisions of the economic agents. For the deindexation process, fixing the exchange rate played a central role. It is worth noting that some observers have accorded the Austral Plan a much more limited role than stabilisation, viewing it more as an instrument aimed at preventing the Argentinean economy from sliding into a full hyperinflation.' At the beginning of 1986 the Brazilian government announced the Cruzado Plan, which was very similar in spirit and design to the Aus- tral Plan. A central component of this plan was the freezing of prices. It also foresaw an initial increase in salaries, but then they too would be frozen. In addition, all forms of indexation were eliminated and a very complex system for adjusting contracts was put into effect.'() At the end of 1985, almost contemporaneous with the Austral Plan, the Bolivian government unveiled its stabilisation programme. This was based on exchange rate unification, which would be aided by very restrictive monetary and fiscal policies. Moreover, and very importantly for the credibility of the programme, there was a very broad liberalisation of markets for goods and factors of production. A standby accord with the IMF reinforced public confidence in the plan and played a decisive role in its consolidation. In fact it is in Bolivia, among the Juan Antonio Morales l 1 six countries of this study, that one sees most clearly the importance that IMF supervision can play in convincing the public of the anti- inflation commitment of the government." The plan was an orthodox shock with respect to fiscal adjustment and the strict control of internal credit, its two most important components. Later, beginning in January 1986, when the government began explicitly to use the exchange rate as an inflationary anchor, the programme acquired a slighly more heterodox character, and the suspension of payments to international commercial banks introduced a further heterodox component to the Bolivian stabilisation plan. The diagnosis that inertial inflation plays an important role in the destabilisation process is the basis for the heterodox plans. On the other hand, as indexation was relatively uncommon in the Bolivian experience, the analysis of its inflation was almost uniform in its search for conventional causes and cures. Given that the Bolivian economy was essentially one of flexible prices - largely due to its low degree of industrialisation - and that it was very dollarised, traditional anchors such as the exchange rate and, to a lesser degree, public prices were sufficient to halt inflation. Nevertheless, the ability to maintain these anchors depended directly on very strict monetary policies. The Bolivian stabilisation programme achieved very rapid success. This can be explained by the nature of hyperinflation, which bears the embyro of stabilisation. Bringing about stabilisation, given the hyperinflationary conditions, was not very complicated. The difficult part was to sustain it, and this was achieved in large part by the extensive international cooperation that the programme attracted. Starting from the last quarter of 1985, net resource transfers turned in Bolivia's favour. We also conjecture, although the evidence is not conclusive, that the recuperation by the Central Bank of large amounts of dollars from the illegal drug trade was also an important component of stabilisation.

The `Peaceful' Stabilisations

The principal objective of the economic programme of the Uruguayan government was to increase the supply of exportable goods. Fiscal and monetary policies were designed to attain this goal. The other priority was to sustain the solvency of the financial system, which has a fundamental role in the Uruguayan economy. Price stabilisation, the reduction of the public sector deficit and the strengthening of the balance of payments were also important considerations, but they did not 12 Economic Policy after Transition to Democracy

monopolise the discussion on economic policy as in some of the other countries. The favourable external situation was an important factor in the success of the Uruguayan programme, at least initially. The improvement in the terms of trade plus the situation in Brazil provided a unique stimulus to exports. On the other hand, the climate of dialogue brought by the return to democracy contributed to the stabilisation of inflation by allowing for a loosening of distributive tensions. It is necessary to distinguish two phases in the economic developments that took place during the Uruguayan transition. From 1985 to 1987 production and employment returned to precrisis levels. However this provoked a strong increase in imports and threatened the current account balance. This resulted in the need for an internal adjustment in the second phase, from 1988-9, which caused the economy to stagnate. The role of the real exchange rate was central to economic policy, especially in the second phase. The transition government reaffirmed the floating of the exchange rate with limited intervention by the Cen- tral Bank in order to avoid strong fluctuations. There was no return to the use of the exchange rate as a nominal anchor, the policy followed in the early 1980s. The exchange rate could thus align itself at the level required to maintain international competitiveness. In fact, the decade ended with the real exchange rate at its highest level in twenty years. When Aylwin and the Concertacion de Partidos por la Democracia (Coordination of Parties for Democracy - a centre-left alliance) took power the Chilean economy was in much better condition than those of the other countries discussed in this book, although this does not imply that there were no macroeconomic disequilibria. In the last two years of the Pinochet government there had been an excess of internal expenditure and an overheating of the economy that pushed the rate of inflation and imports higher than acceptance levels. There also was the difficulty of maintaining the high real exchange rate of the previous years as the country was awash with international reserves due to a great inflow of foreign capital. 12 Regaining control of the macroeconomic equilibria was the first priority in 1990. During the first three quarters of 1990 the democratic government had to undertake a very large macroeconomic adjustment. The principal instrument for this adjustment was the interest rate. While this resulted in an economic downturn, at the start of the fourth quarter the economy began to grow rapidly once again, as it continues to do over four years later. Juan Antonio Morales 13

The Aylwin government, faithful to the electoral platform of the Concertacion, opted to maintain the structural characteristics of the economic model developed by the military government. The main differences with its predecessor came in the areas of social policy and labour market institutionality. Three aspects of its programme are particularly worth emphasising: (1) a fiscal reform aimed at increasing the revenues the state could use in the area of social policy; (2) a reform of the labour legislation; and (3) the privatisation process was frozen. In Chapter 7 Munoz and Celedon stress that, according to the Concertacion programme, the social programme and changes in the labour laws had to respect the limitations imposed by an economic policy that gave top priority to stabilisation and growth. On the return to democracy in 1989 the inflation rate in Paraguay was 25 per cent, high by international standards and the experience of the country, but very far from the catastrophic rates being suffered by several of its neighbouring countries. A few weeks after Rodriguez assumed power his government implemented very significant corrective measures. The most important of these were an exchange rate reform, which included a move to a system of dirty floating and unification of exchange rates, a reduction of the fiscal deficit, and adjustments in monetary and credit policy. The reforms to the financial system were particularly important: deregulation of interest rates, elimination of sectorally directed credit, and higher reserve ratios and discounts for the commercial banks.

1.5 FAILED STABILISATIONS AND SECOND-ROUND SUCCESSES

The Argentinian Austral Plan was sustained for less than two years, mainly because of continuing inflation and unexpected events in the external sector. With regard to inflation, the relatively low rates observed in the first months of the plan were not sufficient to lengthen the terms of financial contracts nor to suppress the indexation of salaries. On the other hand, the deterioration of the external situation, caused largely by a substantial fall in the terms of trade (by 37 per cent from 1984 to 1987), demanded a high real exchange rate. Thus, the government was obliged to devalue by 3.2 per cent in April 1986. This led to an acceleration of the devaluation of the currency, which reached 34 per cent between March and December 1986. However, even this strong devaluation was not enough to remedy the situation. Moreover, due to 14 Economic Policy after Transition to Democracy disequilibria in several internal markets, the government had to make a number of `price corrections'. The strong devaluation coupled with the price adjustment destroyed the credibility of both the programme and the commitment of the government to fight inflation. A number of similar programmes followed the Austral plan, although each time in more unfavourable conditions. The failure of the Primavera Plan, the last stabilisation attempt of the Alfonsin government, was one of the immediate causes of the hyperinflation that took place in the second quarter of 1989. The gravity of the situation forced Alfonsin to cut short his presidential term by six months, and he handed over the presidency to Carlos Menem in July 1989. All of this echoed the experience of Silez Suazo in Bolivia six years earlier. In Brazil, the Cruzado Plan was followed by similar programmes - the Bressner Plan and the Summer Plan, in both of which the freezing of prices played a central role. In 1990 President Collor implemented a new stabilisation plan with more orthodox measures, such as the search for fiscal equilibrium. Except for a very short period, price freezes were not considered. The most unique measure of the plan was the obligatory freezing of approximately 70 per cent of financial assets for a period of 18 months. Despite its drastic nature, this plan also failed. Collor tried once more to stabilise during his presidency but with the same results. Similarly, the government of Itamar Franco, who replaced Collor, has not been able to obtain stabilisation. Infla- tion continues to be a very serious problem, in contrast with the experience of the other five countries. In Chapter 4 Amadeo emphasises that the capacity of the government to reestablish fiscal equilibrium and reduce inflation has continually declined since the middle of the 1980s. He also stresses that, in addition to the problems caused by servicing the external debt, fiscal difficulties are closely associated with the nature of the political process in Brazil and the types of relationship between state and society. As examples he cited the ad hoc nature and structure of subsidies and the expansion of public employment in the first years of the transition, both of which were greatly influenced by clientelistic politics. He also insists on the political difficulties of widening the tax base and putting more emphasis on direct taxes.

The Convertibility Plan of Argentina

Menem began his government with a very broad mandate. Despite that, his first attempts at stabilisation failed, and between December 1989 Juan Antonio Morales 15 and March 1990 Argentina suffered its second hyperinflation. How- ever, the Convertibility Plan, which began in April 1991, brought a halt to inflation. The five principal elements of the Convertibility Plan were (l) a fixed exchange rate; (2) the convertibility of domestic money by law, which required the Central Bank to maintain international reserves equal to 100 per cent of the monetary base; (3) a substantial improvement of the fiscal accounts; (4) trade liberalisation; and (5) the prohibition of indexation clauses in all contracts. The 100 per cent reserve requirement clause was especially important because it eliminated the option of the central government, the provincial governments and the public sector to use the Central Bank as a lender of last resort. It is important to add that about a year after the plan began, Argentina obtained a very important international accord within the framework of the Brady Plan with its creditors among the international commercial banks. The favourable stabilisation result was due in large part to the preparatory work undertaken by the Menem government, principally in the fiscal area, where very significant improvements were made in tax collection and the size of the public sector was reduced through privatisation. The lengthening of the terms of accumulated domestic debt also had important effects. Finally, the fixed exchange rate, difficult to change, and the law of convertibility had important impacts on expectations, which complemented the fiscal effort.

Additional Considerations about the Economics of the Stabilisations

The stabilisations, whether of the first or second rounds, succeeded in lowering inflation rates, at times conclusively. However, the reduction of inflation does not imply that all of the disequilibria had disappeared. It is necessary to mention, in particular, that the stabilisations in both Argentina and Bolivia were obtained by overvaluing the exchange rate. Correction of this overvaluation was only brought about in Bolivia once stabilisation had been consolidated. Moreover, it was helped to a large extent by exogenous factors such as overvaluation in neighbouring countries, which are important trading partners of Bolivia. The task of correcting the overvaluation of the Argentinean peso remains to be done. Even the job of controlling inflation is still far from complete. By 1992 the most effective programme in reducing inflation in the region was that of Bolivia.' Nevertheless the fragility of the financial and 16 Economic Policy after Transition to Democracy fiscal systems continued for several years after 1985. The inflation rate seemed to be trapped in the 15-25 per cent range. Although these were relatively moderate rates, they far exceeded average international inflation rates. In 1993, for the first time, inflation fell below 10 per cent. The stabilisations of both Bolivia and Uruguay have quite unexpectedly been accompanied by a large dollarisation of the deposits in the banking system. In Argentina, dollarisation, which fluctuated widely and was correlated with periods of high financial fragility before the Convertibility Plan, has continued to increase with this plan, despite its success. Dollarisation poses new questions about the nature of the stabilisations. In the other three countries, dollarisation has not been of much significance. To conclude this subsection, we would like to bring into the discussion the influence of exogenous factors for successful stabilisations. For example, the foreign trade scenario was very different in Uruguay than in Argentina and Bolivia when they initiated their stabilisation plans in 1985. This partly helps to explain the different results in the three countries in the last half of the 1980s. On the other hand, there is little doubt that the substantial respite that Argentina received in 1990 with respect to its external debt, due to negotiations and the large fall in international interest rates, contributed to the success of the Convertibility Plan. In addition, the fall in international interest rates has played an important part in the large inflow of capital since 1991.

Additional Considerations about the Politics of the Stabilisations

With the exception of Chile, the manner of designing and implementing the stabilisation policies changed very slowly from the procedures used during the military governments. In the other countries the executive power exercised almost total dominion, relegating the legislative power to a minor position. A common characteristic of the successful shock programmes was the concentration of power in the hands of the president and several high functionaries in the economic areas of the government. The stabilisation measures were usually made public by supreme decrees and similar administrative instruments, although they had to be approved by the legislative power whenever necessary. An important characteristic of the second democratic governments of Argentina and Bolivia, the ones that succeeded in stabilising their economies, was that they governed on the fringe of the political parties that had helped them to be elected. The cabinets of Menem and Juan Antonio Morales 17

Paz Estenssoro consisted mostly of business persons and technocrats, and at times the appointments were strongly resisted by the government party. As noted by Damill and Frenkel in Chapter 3, due to the urgent need for stabilisation administrative power often displaced political negotiation and cooperative and participative strategies were abandoned in Argentina. In emergency situations it is necessary for the state agent rapidly and effectively to coordinate collective action. In Argentina, that agent was the executive power. We must emphasise that the authoritarian manner of formulating and undertaking economic policy was typical of the stabilisation programmes, although the structural reforms were introduced with a little more care, except in the first Argentinean reforms. The concentration of power in the hands of the executive increased the dependence of political success on economic success. The political agenda was abnormally defined by the results on the economic front. Paradoxically, this feature of the political process had consequences for the executive power itself, which in spite of its original hegemony later lost ground in decision making and action taking. An important question in the case of the Argentinean and Bolivian transitions is why was it that only the second democratic governments were able to bring about stabilisation? The reply could be that it was because the governments of Alfonsin and Siles Zuazo had become so feeble - partly due to their initial errors - that it was virtually impossible for them to enact the necessary and tough measures with the required firmness. Nevertheless, the new (second) governments enjoyed the power usually granted to newcomers, and they were better equipped than their predecessors to resist the opposition that naturally arises in the face of serious stabilisation measures. The work of the new political economy emphasises that a new and strong government can dis- tribute the costs of adjustment among the different social groups without fear of being paralysed by the opposition," Moreover, the disequilibria and instability had become so strong that positions may have been reached where all or most social groups benefited by stabilisation. Although it appears from the countries of this study that strong governments are better able to bring about stabilisation and make economic reforms, Paraguay is an exception to that rule. Moreover, its case is interesting because without the pressure of difficult external circumstances, the government that replaced the dictatorship would have taken the necessary corrective measures, even though it clearly had the option to postpone them. 18 Economic Policy after Transition to Democracy

1.6 THE ECONOMIC REFORMS

The requirements for macroeconomic stability completely dominated the design of economic policy during democratic transition in the six Latin American cases. In all the countries there was a clear primacy of macroeconomic policy over sectoral policies. Although in Chile macroeconomic policy was also the main instrument of economic policy, it was oriented at maintaining a vigorous growth rate and rein- forcing international competitiveness, as stability had already been attained. The severe macroeconomic crises prepared the ground for the subsequent structural reforms of a microeconomic nature. In the footsteps of the stabilisations, there appeared, at first not very explicitly, reforms that implied profound changes in the patterns of investment and saving, as well as the allocation of resources. A large number of these reforms were driven by the international financial institutions (IFIs), which were promoting a new orthodoxy based on the control of financial and macroeconomic disequilibria, on trade and capital market liberalisation, and on privatisation. Williamson (1990) has called this list of recommendations the `Washington Consensus'. The IFIs pressed, each time more subtly, the countries to adopt measures following this consensus. At the beginning it was often believed that many of the reforms were transitory. They were viewed more as additions to the stabilisation programmes to increase their credibility than as instruments of radical change. Only later did the general public realise, somewhat to its surprise, that an economic and social revolution had taken place. The sequence of the reforms, while of secondary importance, gave rise to an extensive debate amongst academics of the region and the research departments of the IFIs. The recommendation was also made, and until 1985 was rarely questioned, that countries needed to stabilise before liberalising their markets. The operational departments of the IFIs, which were more audacious than their research departments, pressed the countries to adopt the measures very rapidly, which moreover were to be all-inclusive. The conflicts between stabilisation and structural reforms received a somewhat more careful treatment in Chile and Uruguay. For that reason, in those countries stabilisation and a high real exchange rate were not incompatible. The structural reforms were implemented quite easily as there was hardly any political resistance. The traumatic experiences of hyper- Juan Antonio Morales 19 inflation in Argentina and Bolivia increased significantly the executive powers' room to manoeuvre in the area of economic policy. More- over, the opposition to the orthodox stabilisation plans had almost completely debilitated the political strength and energies of the unions and the lower middle classes, who bore the direct costs of the reforms. Similar to the stabilisation programmes, one of the objectives of the structural reforms was to increase investment rates. However, contrary to expectations there was no significant recovery of investment in the second half of the 1980s, except in Chile. In Argentina, the reforms only began at the beginning of the 1990s and the rate of investment, after a collapse in the 1980s, recovered to a great extent. Bolivia and Uruguay were the most extreme cases of low investment. Even the increase in the investment rate in Bolivia after 1988 was essentially due to public investment; the private sector did not respond as expected to the new stimulus. Between 1986 and 1990 private investment as a proportion of GDP was 7 per cent on average, lower than during the serious crisis of 1982-5. The behaviour of private investors was equally timid in Uruguay, private investment being 30 per cent lower in the democratic period than during the crisis of 1982-4. In Chapter 5 Macadar stresses that the renewal of economic activity in Uruguay came from the restoration of production lost during the crisis, rather than because of a new configuration of production based on the sectors of greater comparative advantage or the incentives created by the economic reforms. In order to reach a new industrial structure, large amounts of new investment were necessary. By the end of 1990 the Chilean economy was once again on the path to rapid growth, with a strong expansion of exports and reductions in the fiscal deficit and inflation. In Chapter 7 Munoz and Celedon note two exceptional results: (1) the economy grew vigorously despite the global recession - that is, there was a delinking of the growth of the domestic economy and that of the international economies; and (2) in contrast with the boom at the end of the 1970s, which was based on foreign savings, the new boom was founded on a dynamic export sector, high rates of investment and high rates of domestic saving. Munoz and Celedon conclude that Chilean growth is based solidly on the country's own resources, stimulated by a coherent economic policy. The low rates of investment were one of the principal problems of the Chilean economy between 1973 and 1986. In 1987 they began to rise quickly. The highest rates obtained between 1973 and 1992 occurred in the democratic period - 1990-2 (24 per cent of GDP on average). 20 Economic Policy after Transition to Democracy

In spite of the centrality of fiscal reform in the economic reform, in many of the countries much work has still to be done. With the possible exceptions of Chile and Argentina, all the countries have a great amount to do with regard to improving the structure and administration of taxes and reorienting public expenditure towards the social sectors. Reform of the quality of this expenditure is an important as changes in its size and composition. The distribution of public resources continues to be a particularly difficult problem. Amadeo (Chapter 4) asks the question at the heart of the matter: which universal programmes based on the principal of equity will survive? He cites the example of the deterioration of basic state education, one of the more perverse distributive results of the budget cuts. A principal reason for this situation is that the families that use state education are poorly organised as they are ill-informed and poorly educated.

1.7 THE INTERACTIONS BETWEEN POLITICS AND ECONOMICS DURING THE TRANSITION

The distinct economic situations as well as the distinct economic policies explain the political reactions of the various social actors. How- ever, at the same time the economic policies could not be exogenous to distributional considerations or the struggle for political power. The political processes and the collective reactions of the different social actors were important determinants of economic policy.

The Business Community

In Chile, despite a growing economy and the basic macroeconomic equilibria being in place, the initial reaction of the private sector was distrust. On the one hand, entrepreneurs were suspicious of the parties in the Concertacion, which historically had been perceived as the en- emy. On the other hand, there was fear that the many successful economic reforms introduced by the Pinochet government would be reversed. This mistrust prevailed throughout the first year of the democratic government, and it could be conjectured that it determined the course taken by subsequent economic policy. The macroeconomic adjustments of the first year of the democratic government intensified the private sector's distrust. The entrepreneurial community believed that the government had overreacted to the Juan Antonio Morales 21 overheating of the economy. Moreover the fiscal reform, the labour market reform and the paralysation of the privatisation process added to their disquiet. Given this situation Aylwin realised that his government had to gain the confidence of the business community, although it should be noted that, in spite of the above, private sector opposition was moderate. The government was unexpectedly boosted by the split of the right, which had divided in the time between Pinochet's plebiscite and the elections. According to Munoz and Celed6n (Chapter 7), the right split into a faction with a modern and rejuvenated political focus and one that was vindictive and conservative, based more on personalities and charisma than on coherent political programmes. Once growth had been reactivated the private sector's optimism was reawakened and the initial distrust disappeared. The acceleration of growth, the strong increase in domestic savings and investment, the decrease in inflation and the fall in unemployment reassured the entrepreneurial community of the appropriateness of the economic policy being followed and of the capability of the economic authorities. Objections to the fiscal and labour market reforms persisted, but with less intensity." The government had not only overcome the initial lack of confidence but had opened important channels for cooperation with the business community in various areas. In effect, an equilibrium was reached between the interests of the Concertaci6n government and those of the business community. The private sectors of Argentina, Uruguay and Paraguay were, at least initially, sympathetic to their respective democratic governments. In Argentina, the Radical Party was viewed as more allied to the entrepreneurial community than was the Peronist Party, which had a long interventionist tradition, but when the Radicals were unable to control inflation they lost this confidence. In Uruguay, as economic policy substantially improved the situation of the workers without affecting the return to capital, the government received the backing of the business community, at least in the first phase. The policies that generated these results were made possible, as we have seen, by the external accounts receiving several favourable shocks. In Paraguay, the private sector initially assisted the plans of Rodriguez' government to liberalise the economy, but by the end of his term relations with the business community had deteriorated substantially. This deterioration came in part from divisions within the private sector itself in terms of economic policy. The powerful Confederation of Private Enterprises of Bolivia 22 Economic Policy after Transition to Democracy

(Confederacion de Empresas Privadas de Bolivia or CEPB) had strongly declared itself in favour of democracy and the end of military dictatorship. However, once the democratic government of Sites Zuazo had been installed the CEPB consistently opposed it, mainly because of the presence of the Communist Party of Bolivia in the governing coalition. Contrary to what occurred during the Sites Zuazo government, the CEPB publicly supported the reform programme of Paz Estenssoro. Moreover, in a situation not heard of since the end of the nineteenth century, there was a large entrepreneurial participation in the cabinet of Paz Estenssoro as well as the highest posts of public administration.

The Unions

Relations between the unions and the governments of Argentina, Bra- zil, Paraguay and Bolivia were also different than in Chile and Uru- guay. In the latter group the search for areas of cooperation with the workers' movements gave a special characteristic to the economic policies of the democratic transition. Relations with the unions in Chile were facilitated by the labour market legislation undertaken by the democratic government as well as by the vigorous economic growth. The new legislation widely recognised union activity; the surviving limitations were aimed at reducing avoidable confrontations between owners and workers, as well as excessive ideological stances in the negotiations. For its part, the favourable evolution of the economy facilitated better pay and a large fall in the rate of unemployment. The Uruguayan unions cooperated actively with the first democratic governments. They participated in the `Concertacion Nacional Programatica' (CONAPRO), which also included representatives of the political parties, social organisations, entreprenuers and students. The main document of CONAPRO, distributed a few days before the beginning of the constitutional government, contained the basic elements for a coordinated economic policy. However, the good relations between CONAPRO and the government ended after a few months, the government having introduced an economic policy that differed from the one in the Concertacion's accord and which was rejected by the unions. Nevertheless, this disagreement did not affect macroeconomic stability, due to a large extent to the favourable external circumstances. Once democracy had been restored in Uruguay, the most important change in economic policy concerned wages and salaries. In Chapter 5 Macadar points out that during the dictatorship, salaries in the private Juan Antonio Morales 23 sector had been fixed administratively. After the reorganisation of the unions, wage adjustments were negotiated with salary councils, in which participated owners, workers and the government. The salary policy did not ignore economic restrictions, especially those related to the external sector. Nevertheless, salaries and pensions experienced a notable and sustained improvement from 1985-90. This was brought about by transfers of income from the most productive sectors and by the external transfer of income resulting from the improvement in the terms of trade. This situation changed, however, at the beginning of 1990, when a reversal in the terms of trade led to a fall in real wages. In Argentina, the General Confederation of Workers (Confederation General del Trabajo or CGT), traditionally allied with the Peronists, tenaciously opposed the Radical government. It has continued to oppose, although with less force, the economic reforms of the Menem government. In recent years it appears that the organised workers' movements have lost a great deal of political influence. With democratisation in Brazil there emerged an autonomous and very militant union movement, which showed a notable ability to organise. The increase in the negotiating power of the unions in the context of a very protected industrial sector was one of the main forces that prevented any substantial reduction in inflation, as Amadeo notes in Chapter 4. In Bolivia, Sites Zuazo was supported for a brief period by the unions, but his government fell out of their favour after its failed stabilisation attempts. In fact, one of the principal factors aggravating inflation between 1982 and 1985 was virulent union opposition. In sharp contrast, the power of the unions decreased drastically after the economy had been stabilised by the government of Paz Estenssoro. In Paraguay, the organised workers' movement, which had been sup- pressed during the Stroessner regime, reactivated itself. As a signal of their regained independence, the different worker confederations displayed opposition to the economic policies of the transition government, accusing it of maintaining unemployment and causing real salaries to fall. Despite its renewed activism, its power to influence economic policy has been very limited to date.

The Political Parties

In Argentina and Bolivia the errors committed by the governments in the management of their respective crises almost immediately had a 24 Economic Policy after Transition to Democracy resonance in the political parties and coalitions of which they were composed. There soon followed internal crises, disagreements with respect to economic policy were made public, and there began to appear `alternative' programmes of stabilisation to those proposed by the executive, which of course weakened the latter. The dissensions read- ily translated into divisions and distancings, with profound ramifications for the economic policy the government was trying to implement. Opposition to the governments of Siles Zuazo and Alfonsin, entrenched especially but not exclusively in parliament, obstructed almost all the measures necessary for stabilisation. The government's fear that it would lose the support of its own party members produced delays and even paralysis in its decisions. Political instability began to interact with economic instability, rein- forcing its undesired effects. That the first democratic governments of Argentina and Bolivia were maintained in spite of extremely difficult political conditions was essentially because a return to unconstitutional forms of government was not considered a viable alternative. In an almost generalised manner the political parties in the six countries broke with tradition during the transition to democracy, although at different moments. In several countries, the changes were extremely surprising. The parties that had formed the Popular Unity (Unidad Popular) during the period of Allende, upon entering into the Con- certacion showed a very significant ideological evolution. Munoz and Celedon (Chapter 7) note that those parties (1) tempered their criticism of the economic model established by Pinochet, (2) recognised the positive aspects of the existing economic structure, and (3) recognised the importance of both private property and entrepreneurs in the development process. In Bolivia, both the Nationalist Revolutionary Movement (Movimiento Nacionalista Revolucionario, or MNR) as well as the Leftist Revol- utionary Movement (Movimiento de la Izquierda Revolucionaria, or MIR) broke with their populist and Marxist roots. The first surprise came when the MNR proposed a programme of liberal economic reforms, and the second was when the MIR extended and deepened the changes towards market liberalisation. Argentina saw a similar evolution. Although it would be difficult to categorise the Alfonsin administration as populist, the failure of its macroeconomic stabilisation plans convinced the Peronist leaders that it was necessary to follow more orthodox and liberal policies. Menem perceived correctly, and successfully transmitted this perception to his party, that the priority for society was economic stability; any other Juan Antonio Morales 25 claim would have to take second place. As Damill and Frenkel note in Chapter 3, this societal demand increased Menem's room to manoeuvre. To the correct perception by the government of the societal demand for stability was added another, somewhat more debatable judgement; that is, the only way of convincing the public of the government's commitment to fighting inflation was by following the orthodox policies recommended by the IFIs and the Washington Consensus, even exaggerating some of their characteristics if necessary. The government of Sanguinetti in Uruguay, which assumed power in May 1985, also resisted populist temptations. It did not ignore the restrictions caused by the economic crisis, but decided to overcome them by combining more or less orthodox policies - at least they did not meet the disapproval of the IMF - with the cooperation of the principal social actors. Macadar emphasises in Chapter 5 that the political parties moved to the centre of the social spectrum, with a flexibility and ability to absorb and neutralise social tensions as well as to harness the complex political conflicts. The different social groups limited their dissent and contributed to the consolidation of the restoration of democracy, supporting the actions of the parties. In the countries where the military governments had permitted some political activity and Congress, although controlled by the executive, had remained open, the political parties, even when they were of the opposition, did not suffer the unexpected mutations found in the countries where they had no opportunity to express themselves. Although the military governments in Brazil had greatly restricted political activity, for the most part they had allowed Congress to remain open. Never- theless, only two parties - the National Renovation Alliance (Alianca Renovadora National, or ARENA) and the Brazilian Democratic Move- ment (Movimiento Democratico Brasileiro, or MDB) - were allowed to operate. The former was the official party and the latter the opposition. For these parties the democratic transition meant a less radical departure from their (at times populist) past than was the case in the other countries. Still, as in the case of Alfonsin, it is difficult to categorise Sarney and the MDB as populists. Rather, Sarney was a weak leader who did not dare to go against the opposition that came from various sources, both national and international. It should also be noted that the last years of the military government saw the reappearance of the Workers' Party (Partido de los Trabajadores, or PT), which became the principal opposition party, with a leftist platform with well- defined characteristics. 26 Economic Policy after Transition to Democracy

In Paraguay, both Rodriguez and Wasmosy belong to the Colorado Party, one of the traditional ones. When Wasmosy ends his term the Colorado Party will have held the presidency for more than fifty years. However, although Wasmosy was a member of the party before his presidential candidacy, he was never active in it. The factions that oppose him, in a deeply divided party, are more conservative than he is in the political and economic fields.

Human Rights

An important matter in the democratic restorations, which significantly affected governability and economic policy, was that of reparation of the human rights violations that took place during the military dictatorships. The problem had different intensities and was solved in very different manners in the six countries. In Argentina, this problem resulted in the most acrimony. In Brazil, on the other hand, the theme was barely touched upon, and played no destabilising role later on. In Par- aguay the attention given to reparation has been even less than in Brazil. Alfonsin's government energetically brought to trial those most responsible for abuse against civilians at the time of the military dictatorship. Unfortunately this provoked a series of military revolts, which significantly weakened the new democracy and even put its future in danger. The pressure from the armed forces caused the governments of Argentina and Uruguay to grant general amnesties and end their investigations." In Uruguay a referendum was held after the amnesty law had been passed by the government, but it did not reach the majority needed to repeal it. The first democratic government of Bolivia approached the problem by charging the armed forces to purge themselves of the officers who had committed crimes against humanity. This solution, although imperfect, prevented the development of a situation in which the military could destabilise the civilian government. Later, during the second civilian government, a `trial of responsibilities' (Juicio de Responsabilidades) took place for the principal members of the military government of 1980. This trial ended in 1993 with severe sentences for the defendants. The democratic government in Chile acted in a different manner than in the other countries. Its policy was based on clarification of what had occurred during the dictatorship, on moral and material reparations to the victims of the repression, and on sanctions for those responsible. This, however, was to be done in a manner that would avoid a destabilising reaction from the armed forces. To attain these goals Juan Antonio Morales 27 the judicial demands had to be placed by the victims of abuse or their families, without the participation of the government. After a shocking political assassination by an extreme left-wing group, the government moved the question of reparation further down its political agenda.

1.8 FINAL COMMENTS

After the extensive political and economic moves of the previous decade, the first years of the 1990s seem to offer promise for the future. Democracy appears to have been strengthened after weathering dangerous attacks arising from the very severe economic crises. Argentina, Uru- guay and Chile have elected democratic governments for the second time. Brazil is preparing for its third democratic election. Paraguay is enjoying a civilian government for the first time in decades. Even in Bolivia democracy has remained firmly in place, and in 1993 it elected a civilian government for the fourth time in succession. In all but Brazil the battle against inflation is being won, although it is still high in comparison with the industrialised countries." The economies are also more open to external trade and international capital flows. Another noticeable feature is the reduction in the size of the public sector, which had grown to unwieldy proportions in the 1960s and 1970s with the models of state-led industrialisation. Despite the economic progress of most of the countries of the study, there still remain problems of credibility, which can be seen especially in the low rates of investment in comparison with the historical norms. Only in Chile have investment rates been high throughout the transition. In almost all the countries there has also been a problem of low rates of domestic saving. The exchange rate, due to its importance in macroeconomic management, continues to be an object of special attention. We have emphasised throughout this introduction that the successful economic policies of both Chile and Uruguay were based on a high real exchange rate. On the other hand, the Argentinean and Bolivian stabilisations and structural reforms took place by appreciating the currency, which has left their economies with a fragility that is difficult to eliminate even years later. The six countries, whether as a result of the crisis of the 1980s or for more historical reasons, will continue to confront important problems of income distribution and, in several of their regions, extreme poverty. Poverty in strongly depressed areas has still not received substantive 28 Economic Policy after Transition to Democracy attention from public policy, with the possible exception of Chile. Given the continuation of macroeconomic stability and improvement of the rates of investment and growth in countries where they are still low, the problems that the six countries will have to face near the end of this century will be more akin to those of a mature economy. Chap- ter 7 provides the best summary of these challenges: (1) an improvement in social equity; (2) an increase in international competitiveness, based on productivity gains and development of institutional capacity, rather than on low salaries; and (3) an improvement in the quality of public sector management, emphasising the new roles of a modern state.

Notes

* The author would like to thank Mario Damill, Luis Macadar, Gary McMahon and Carlos Salinas for their valuable suggestions. 1. The expression `second transition' comes from O'Donnell (1994), in a somewhat different context than in our discussion. 2. This classification was suggested by Carlos Salinas. 3. The schedule was to have one more military government in order to guide the transition. However, due to popular pressure, in 1985 a civilian president, Tancredo Neves, and vice-president, Jose Sarney, were elected. When Neves died before taking office, Sarney assumed the presidency. 4. To be precise, external circumstances provoked the reversal of the reforms in Argentina in 1981-2, when the military government was still in power. The democratic government, which had no clear perception of the benefits of the reforms and even less consensus about them, continued in the same direction as the military government in its last two years. 5. In the other countries the external debt crisis also caused fiscal crises, but more spread out over time. 6. The dedollarisation was part of a monetary reform consisting of the forced conversion of contracts in dollars to domestic currency. 7. Despite the general character of the last statement, it should be noted that several Peronist union leaders cooperated with the regimes of Videla. Viola and Galtieri, as noted by Damill and Frenkel in Chapter 3. 8. It is worth noting that the Bolivian stabilisation plans of April 1984 and February 1985 were not very different in their content from the successful plan of August 1985. 9. There are many explanations of the contents of the Austral plan, as well as why it failed. See, for example, Canavese and Di Tella (1988), Machinea (1990) and Heymann (1991). 10. For details of the Cruzado Plan, see, among others, Modiano (1988) and Cardoso and Dornbusch (1987). 11. Edwards (1993) outlines the theoretical reasons behind the consolidating role that an international organisation can have on the expectations of the public. Juan Antonio Morales 29

12. It is necessary to remember that Chile abandoned the fixed exchange rate system in 1982. Between 1982 and 1988 the real exchange rate de- preciated strongly. 13. In several months of 1993 the rate of inflation in Argentina was less than that in Bolivia. 14. See Edwards (1993) and various references cited in his paper. 15. We do not mean that the private sector was completely committed to the direction in which the government was leading the economy. There still existed criticisms with regard to the size of the state, the discontinuation of the privatisation and excessive public expenditure. 16. The pardon of the military commanders in Argentina took place during the Menem government. 17. In the second half of 1994 the Brazilian government too had considerable success in its fight against inflation.

References

Alesina. A. and A. Drazen (1991) `Why are Stabilizations Delayed?', Amer- ican Economic Review, vol. 81, no. 5, pp. 1170-88. Canevese, A. J. and G. Di Tella (1988) `Inflation Stabilization or Hyperinflation Avoidance? The Case of the Austral Plan in Argentina, 1985-87', in M. Bruno et al. (eds), Inflation Stabilization (Cambridge, MA: MIT Press), pp. 153-190. Cardoso, E. and R. Dornbusch (1987) `Brazil's Tropical Plan', American Economic Review, vol. 77, pp. 288-92. Edwards, S. (1993) The political economy of inflation and stabilization in developing countries', National Bureau of Economic Research Working Paper 4319 (April). Heymann, D. (1991) From Sharp Disinflation to Hyperinflation, Twice: The Argentine Experience, 1985-1989', in M. Bruno et al. (eds), Lessons of Economic Stabilization and its Aftermath (Cambridge, MA: MIT Press), pp. 153-90. Machinea, J. L. (1990) `Stabilization under the Alfonsin government: a frustrated attempt', CEDES Document no. 42 (Buenos Aires: CEDES). Modiano, E. (1988) The Cruzado First Attempt: Theory and the Brazilian Case Study', in M. Bruno et al. (eds), Inflation Stabilization (Cambridge, MA: MIT Press), pp. 153-90. O'Donnell G. (1994) `Delegative Democracy', Journal of Democracy, vol. 5, no. 1, pp. 55-69. Rodrik, D. (1993) The Positive Economic of Policy Reform', American Economic Review, vol. 3, no. 2, pp. 356-61. Torre, J. C. (1993) The Politics of Economics Crisis in Latin America', Journal of Democracy, vol. 4, no. 1, pp. 104-16. Williamson, J. (1990) The Progress of Policy Reform in Latin America', Policy Analysis in International Economics no. 28 (Washington DC: Insti- tute for International Ecomonics). 2 Economic Policy in Bolivia after the Transition to

Democracy 1 Juan Antonio Morales

2.1 INTRODUCTION

The main purpose of this chapter is to examine the difficulties involved in the democratic transition in Bolivia and to point out the circumstances that led to the implementation of the liberal economic policy that forms part of the so-called New Economic Policy (NEP). The development and prospects of this policy are also discussed. The return to democracy and its institutions took place in October 1982, whereas the NEP began to be applied almost three years later, after the enactment of Supreme Decree 21060 in August 1985. The chapter covers the administrations of Hernan Siles Zuazo, President of the democratic transition, and Victor Paz Estenssoro and Jaime Paz Zamora, who carried the NEP forward. Democracy resumed in the midst of a profound economic and political crisis. The military administrations of 1982 were forced to abandon power mainly because they were incapable of resolving the serious problems that were afflicting the economy. In the first years of the democratic transition, and contrary to expectations, the situation deteriorated almost to the point of disintegration of the financial and productive sectors. Between April 1984 and August 1985 Bolivia experienced a true case of hyperinflation. Supreme Decree 21060, issued in late August 1985, included a stabilisation programme and a series of structural reforms. The stabilisation programme was quite conventional.2 On the other hand the structural reforms included in the decree, and more generally in the NEP, are not only the most important ones in national terms since the Revol- ution of 1952, they are actually among the most daring in the move towards liberalism in the countries in the region. In the seven years that the NEP has been in force, fundamental steps

30 Juan Antonio Morales 31 have been taken regarding what is, according to liberal views - which are shared by the international financial and technical cooperation agencies - the modernisation of the economy and the state. However there are some criticisms of the NEP that cannot be easily ignored. For example, it must be pointed out that up to now some of the reforms have not resulted in vigorous and sustained economic growth, and that the NEP has produced no significant progress in social development. Several questions remain regarding Bolivia's experience that may also apply to other countries in the region. Was it the inherited situation that made unstoppable the economic crisis in the transition to democracy? To what extent did political factors and the need to guarantee a democratic transition worsen the economic crisis? The crisis explains the strength of the stabilisation programme, but does it also account for the breadth of the structural reforms? Why did the political elites adopt the liberal economic model, and based on what beliefs? What role did international fianancial cooperation play in changing the development model? How does a model evolve once the crisis is overcome and once the way of doing politics returns to a more normal pattern? This chapter is organised as follows: Section 2.2 describes the political context of the return to democracy and the evolution of the economic crisis. Section 2.3 focuses on the subject of stabilisation and the recovery of governability. Section 2.4 includes an inventory of the changes in the principal target of the structural reforms; that is, the public sector. Section 2.5 is devoted to analysing the prospects for the political and economic evolution of the model, once the crisis has ended. Section 2.6 contains some final comments.

2.2 THE RETURN TO DEMOCRACY AND THE DIFFICULTIES FACED BY THE GOVERNMENT

The First Administration in the Transition to Democracy

In October 1982, with the presidency of Dr Hernan Siles Zuazo, Bo- livia's redemocratisation began after eighteen - mostly uninterrupted - years of de facto governments. Siles Zuazo governed with the support of the Unidad Democratica Popular (UDP, the Popular Democrat- ic Alliance), a coalition formed by four political parties - three left of centre and left-wing, one centre - and a conglomeration of not very significant political clubs.3 A few technocrats with no political affiliation also participated in the different cabinets. 32 Bolivia

The new government inherited a very difficult situation. Firstly, Sites Zuazo had to face the effects of the instability created by the military regimes of the three preceding years as well as the ostracism of the international community to which they had been subject. Secondly, it must be taken into account that the great economic crisis of the 1980s had begun only a few months before Sites Zuazo took office. By mid- 1982 the economy had already deteriorated considerably: between January and September 1982, inflation reached 172 per cent. A major reason for the high inflation and the economic crisis in general was the substantial external debt contracted by the military regimes. Thirdly, the typical problems of a transition to democracy must be mentioned. During the long military rule the practice of coexisting with democratic institutions, such as parliament and a free press, had been lost. When democracy reappeared the different social actors had to relearn the rules and mechanisms of democratic interaction. In particular the way of doing politics in the dictatorship years, based on confrontations and unnegotiable positions, took a long time to abandon. Finally, this list of problems must include the disturbing role played by drug trafficking, because of the uncertainties it created for the economy, particularly the exchange market. Unfortunately, sufficient information and a theory to explain the effect of these illegal activities on destabilisation is still lacking. Sites Zuazo proposed at least six stabilising packages. The failure of all six magnified the severity of the crisis but paradoxically prepared the ground for a concrete solution, as discussed below. Inflation reached 329 per cent in 1983, 2177 per cent in 1984 and 8170 per cent in 1985! This hyperinflation was accompanied by substantial drops in the gross domestic product (GDP): 4.5 per cent in 1983, 0.6 per cent in 1984 and 1 per cent in 1985.

Political Obstacles to Economic Management

Political unease acted synergically with inflation; that is, the two factors helped, through mutual reinforcement, to destroy the economy. The obstacles to governability arose both in the heart of the UDP itself and in the labour unions, as well as in the opposition by the right- wing parties and associations of entrepreneurs. The external context, marked by the debt crisis, did not make the government's task easier. Except during the first months and when the government was coming to an end, economic management was mainly in the hands of independent technocrats who adopted measures that were even more orthodox Juan Antonio Morales 33 than those established at the beginning of Siles Zuazo's government, or those that the main political leaders of the government parties believed should be adopted. The quarrels between the UDP leadership and the technocrats severely weakened the government. Furthermore, the UDP itself rapidly broke up into factions, primarily because the parties that formed it had different views on how the economic crisis should be handled. At first, unionised labourers, gathered under the Central Obrera Boliviana (COB), were among the government's most powerful allies. This support changed in early 1984, when the COB verified the failure of the stabilisation packages, the setbacks in terms of salaries, despite large and frequent rises in nominal salaries, and the government's lack of definition. The government, confronted with the COB and the left-wing parties that supported it, was also unable to find backing among the associations of entrepreneurs or among centre and right-wing parties. Its relations with the Confederation de Empresarios Privados de Bolivia (CEPB, the Bolivian Confederation of Private Entrepreneurs) were especially complicated. The CEPB continued severely to criticise the economic policy and the government's efforts to win its acceptance were to no avail. On the other hand, opposition parties, who had almost full control of both chambers in the legislature, stopped - many times for no reason - the few initiatives presented by the executive to try to end the crisis. However it must also be acknowledged that Siles Zuazo made no major effort to work with Congress. To the foregoing it is necessary to add the demands of regional organisations, which had lain dormant during the military regimes but resurfaced during the transition to democracy. These extensive and costly demands were very hard to satisfy, even if some were legitimate. Re- gional problems played a highly destabilising role. Hyperinflation, which was combined with a lack of consumer goods and took place in an atmosphere of confrontation, gave the public the feeling that the situation was untenable. Siles Zuazo, under pressure from the opposition, agreed to shorten his term of office by one year, calling for advance elections, which were held in July 1985. The shortening of the president's term of office had significant economic consequences. The resistance that the government had shown to the demands made by the COB was almost completely withdrawn. Thus, in late 1984, a salary increase of such magnitude was granted - higher even than the expectations of the labour unions themselves - that it was one of the direct causes of the inflation rate for February 1985 - an 34 Bolivia unbelievable 182 per cent - and also of the major social unrest that ensued.

Hyperinflation as a Phenomenon of Political Disintegration

The preceding discussion may help to answer the question of why hyperinflation arose in Bolivia, even though there had been no international conflagration and no civil war (historically, hyperinflation has followed major political upheaval). What seems to be important in the onset of hyperinflation is not in fact war but rather a combination of the tremendous financial effort needed to meet an external commitment and the reticence of government to utilise domestic sources of funds in order to do so, due to the social conflicts that this would cause. Social conflicts make it impossible, in particular, to control fiscal deficits. In turn they have to be funded by increasing the money supply, which contributes almost directly to inflation.' Inflation speeded up in Bolivia when the government was unable to control social reactions to the external adjustment effort. It is worth emphasising the government's weaknesses: it was incapable of collect- ing additional taxes, of substantially reducing its current expenditure, and of securing the required devaluations of the real exchange rate so as to adapt to the new international context.' Would hyperinflation have occurred if there had been no democratic transition? The reply is necessarily ambiguous. Without doubt an antidemocratic government, but one that was strong and had a degree of legitimacy - like the Banzer administration during the period 1971-8 - would have been able to avoid the economic chaos that was becoming apparent at the end of 1982. But it is debatable whether the military regimes of the period 1980-2 would have been capable of doing it. The brutality of some of those administrations left them without the necessary strength to adopt corrective measures. It should be borne in mind that the main reason for relinquishing control and handing it over to civilians lay in the military's assessment of the economic difficulties.

2.3 EFFICIENT ADMINISTRATIONS AND THE NEW ECONOMIC POLICY

Paz Estenssoro's Administration

After the 1985 elections, as a result of an intricate combination of popular vote and election by Congress, Dr Victor Paz Estenssoro was Juan Antonio Morales 35 elected president. His administration started off in the midst of great ambiguities. Although the gravity of the crisis granted him a very broad mandate, his majority was, nonetheless, relatively small. Furthermore, the government party, the Movimiento Nacionalista Revolucionario (MNR, the Nationalist Revolutionary Movement), one of the oldest in Bolivia, appeared to lack the necessary vigour and expertise to face the crisis. However, this political weakness was corrected after a few weeks in power, albeit after the enactment of Supreme Decree 21060, when in a strategic move the MNR formed a legislative alliance with its opponent, the Accion Democratica Nacionalista (ADN - National- ist Democratic Action) under the so-called Pacto por la Democracia (Pact for Democracy). This pact was crucial to the success of the NEP. Even before the pact had been signed, Paz Estenssoro sent very clear signals of his unwavering commitment to the economic policy he had chosen. This message of firmness was assimilated by all social actors. The NEP was executed in a context of strong-armed democracy. Paz Estenssoro believed that putting the economy on a sound footing made it necessary to reestablish the principle of authority - and this fact marks a fundamental difference with the administration of Siles Zuazo. He, therefore, did not hesitate to take strong measures against labour organisations and the more radical left-wing parties. Moreover, the very significant presence of specialists in the government, instead of the traditional politicians, reinforced some of the authoritarian characteristics of his administration.7

The Contents of the New Economic Policy (NEP)

DS 21060 includes two programmes the first on stabilisation and the second on structural reforms. The stabilisation programme consisted in a consolidation of exchange rates, supported by very strict fiscal and monetary policies, and by measures to relieve the external debt burden. It should be noted that the NEP stabilisation programme departed from the standard IMF programme with regard to exchange rate management and in the treatment applied to the external debt. Also, the fiscal and monetary adjustment measures went further afield than is normally recommended by the IMF. Stabilisation was achieved almost immediately and has endured over time: inflation rates were 66 per cent in 1986, 11 per cent in 1987, 22 per cent in 1988, 17 per cent in 1989, 18 per cent in 1990 and 15 per cent in 1991. The structural reform programme included: (1) decontrolling prices, coupled with the elimination of internal controls; (2) opening up the 36 Bolivia economy quite fully to foreign trade and to international movements of capital; and (3) increasing the flexibility of the labour market. The reforms were implemented simultaneously and quickly, frequently without taking into account the sequence recommended by economists from academic spheres and the experience of other countries. It should also be mentioned that all these liberalising measures were conceived as an integral and essential part of the programme to curb inflation and that they were interpreted as structural reforms only later on. The NEP brought about quite a considerable reduction in the size of the central government in the economy. For its direct administration in the area of commodity production, it only kept Yacimientos Petroliferos Fiscales Bolivianos (YPFB) and profitable mines or those with a proven potential that belonged to the Corporacion Minera de Bolivia (COMI- BOL). The remaining companies were handed over to regional development corporations (CRDs) and municipalities.' The NEP also provoked a significant reduction in the size of the Central Bank and the closing of state development banks. It is important to remark that the concept of the NEP was not foreign to international changes in economic and political thinking between 1970 and 1985, which emphasised a more liberal economy in which the state played a smaller role. The adoption of the NEP was not, however, lacking in contradictions. President Paz Estenssoro and the architect of the NEP, his minister of planning Gonzalo Sanchez de Lozada, viewed the NEP more as a way of reconstituting and restoring the principle of authority than as a libertarian objective. The following declaration by Sanchez de Lozada (in ILDIS, Foro Economico 5, 1985, p. 5) illustrates this point:

More than a strictly economic program, the NEP is a political plan tending to the reestablishment of principles that are essential for the operation of the Republic, in the absence of which there is the grave risk of falling into a path leading to the disintegration of the Na- tional State.

Neither Paz Estenssoro or Sanchez de Lozada picked up the classical economic argument that liberalism leads to the best possible allocation of resources, and therefore to an economic optimum, adhering instead to the argument of economics in the sense that Anglo-Saxons assign to the phrase `political economy'; that is, that market liberalisation was the only way to avoid widespread corruption. In their view, a smaller state was the way to reduce the influence-mongering of special interest Juan Antonio Morales 37 groups, which believed that being in government was the best way to obtain, a bigger share in the distribution of the national income.'

A New Interpretation of the Initial Success of the NEP

Aside from the technical merits of the NEP, the factors that allowed this policy to avoid major political resistance should be described. Regarding stabilisation, it can be argued that the attempts during Siles Zuazo's administration, even though they had failed, had exhausted the social actors who opposed this type of programme. Partly for this reason, the COB and the left-wing parties were only able to offer weak resistance to the stabilisation programme and the NEP. The balance of power between labour unions, associations of entrepreneurs and government leaned completely in favour of entrepreneurs. As hyperinflation had been a clear manifestation of a confrontation without winners of different special interest groups, stabilisation implied an (extreme) loss of power for the labour movement. It is worth noting an additional hypothesis. Each attempt at stabilisation, albeit failed, provided information to social actors on the distribution of the costs of stabilisation, a fact that made them review their preliminary evaluations. Reviews of the costs involved finally converged towards a consensus, although probably a precarious one, that hyperinflation had to be overcome given the comparison of the costs involved in stabilisation or in doing nothing. The speedy control of inflation gave credibility to Paz Estenssoro's administration, allowing it to carry out changes that required more time. It should also be added that the resumption of external credit flows contributed significantly to establishing domestic confidence in the NEP. Would the political parties have been able to propose a platform that differed from the NEP? The tentative reply is: not very different with regard to stabilisation but different with regard to structural reforms. The traditional Bolivian approach has been that inflation reflects an excessive monetary expansion caused by credit granted by the Central Bank to the government. Any stabilisation programme, regardless of the political party proposing it, had to include fiscal adjustments. The differences did not concern the assessment but rather the type of measures and the strength and speed with which they should be applied. In structural reforms, on the other hand, there was much less agreement than with regard to stabilisation. The liberalisation of the labour market and of foreign trade, and the privatisations, have met with strong opposition. 38 Bolivia

Continuing the NEP during Paz Zamora's Administration

Despite its rigours, in 1989 the NEP managed to be accepted by most public opinion and the electorate. In elections held in May of that year, the three political parties with similar points of view regarding the NEP - the MNR, the ADN and the Movimiento de Izquierda Revolucionario (MIR - Revolutionary Left-Wing Movement) - obtained 65 per cent of the popular vote. In the elections held in Congress after the popular vote, Jaime Paz Zamora was elected president with the support of an unexpected alliance between the centre-leftist MIR and the right-wing ADN. The MIR and the ADN formed what is known as the Patriotic Agreement (AP). During his campaign Paz Zamora had promised, though vaguely, that he would change the NEP. However a few months after being elected president he announced, through a decree (DS 22407, issued in January 1990), that he would continue with and deepen the liberal reforms of the NEP. In an overall assessment it can be said that Paz Zamora did not make any essential changes to the economic policy of Paz Estenssoro. In fact Paz Zamora adopted policies that were more orthodox. What does show up is a change of style, in comparison with that of his predecessor, which is not lacking in political impact. Paz Zamora found himself facing the dilemma confronted by most social-democratic parties in the region - namely, that if he wanted to apply a policy of redistribution he first had to wait for economic growth to reappear with vigour. He also bet on the fact that growth would occur if the recommendations made by the international financial organisations were rigorously complied with. In addition, he was under pressure from his partner in government, the ADN, which prevented him from departing from the most orthodox version of the NEP.

2.4 PUBLIC SECTOR REFORM

Among its main objectives the NEP includes a deep reform of the public sector. In fact one of the main criteria by which to judge the NEP stems from what has been achieved in reducing the size of the public sector, and in the changes in the formulation of economic policy. Juan Antonio Morales 39

Table 2.1 Consolidated non-financial public sector operations, 1980-90 (in GDP percentages)

Averages

1980-81 1982-85 1986 1987 1988 1989 1990

Current income 37.4 23.0 24.4 22.0 22.4 22.1 23.0 Current expenditure 38.2 28.1 23.2 23.6 21.3 20.9 20.7 Net current transfers 0.0 0.0 0.0 0.0 0.0 0.5 0.6 Current surplus/ deficit -0.8 -5.1 1.2 -1.6 1.0 1.8 3.0 Capital income 0.5 0.1 1.0 0.2 0.7 1.2 1.3 Capital expenditure 6.7 4.3 4.6 5.3 6.8 6.6 6.9 Net capital transfers 0.0 0.0 0.0 0.0 0.0 -0.6 0.0 Capital surplus/ deficit -6.2 -4.2 -3.6 -5.2 -6.1 -5.9 -5.6 Other expenses 0.6 5.9 0.0 0.0 0.4 0.0 0.0 Global surplus/deficit -7.7 -15.1 -2.3 -6.7 -5.5 -4.2 -2.7 Net financing 7.7 15.1 2.3 6.7 5.5 4.2 2.7 External 4.6 1.3 5.5 2.2 4.0 1.7 1.9 Domestic 3.1 13.8 -3.2 4.5 1.5 2.4 0.8

Source: Based on fiscal data from the Unidad de AnSlisis de Politicas Economicas (UDAPE), 1991, Estadistices Economicas No. 2, La Paz. UDAPE data have been deflated according to the money GDP of the Central Bank of Bolivia, with corrections for the years 1988-90.

Budget Administration

Public spending and GDP The strong weight of the public sector in investment and employment was probably the most salient characteristic of the Bolivian economy prior to the NEP. The NEP was intended to change this situation. On the other hand, almost concurrently with its implementation Bolivia suffered a large drop in the price of its two main exports: tin and natural gas. The combined effect of the NEP and the two international price shocks caused a very substantial reduction in the size of the public sector, particularly if it is measured as the ratio between public spending and GDP. That ratio went from an average of 44.9 per cent (current expenditure and capital expenditure) in 1980-1 to 27.6 per cent in 1990 (Table 2.1). The implications of this decrease in the size of the public sector, forced in part by external circumstances as mentioned above, will take time to become fully apparent. 40 Bolivia

Table 2.2 The evolution of public sector social expenditure, 198(1-8 (in GDP percentages)

Health Education' Ministry Social Total of Health' security'

1980 4.1 0.8 1.4 2.2 1981 2.9 0.5 1.2 1.7 1982 3.2 0.4 1.1 1.5 1983 3.4 0.4 0.8 1.2 1984 3.2 0.4 2.0 2.4 1985 3.3 0.4 1.0 1.4 1986 2.3 0.3 0.7 1.0 1987 2.6 0.5 n.d. n.d. 1988 2.6 n.d. n.d. n.d.

Notes: I. Includes transfers from the central government to universities. 2. Funding from the Tesoro General de la Nacion for the Ministerio de Provision Social y Salud Politica does not include expenditure by the Corporaciones Regionales de Desarrollo nor by municipalities. 3. Contributions made by employees, employers and the government to healthcare benefit funds in the social security system.

Source: World Bank, Public Sector Expenditure Review with a Special Em- phasis on the Social Sectors, 1989.

Building tax collection The 1986 tax reform is one of the central components of the NEP. The main tax in the reform is the flat 10 per cent value added tax. There are still no studies on the impact of the current tax structure on personal income. What can be said at this point is that neither equity nor, surprisingly, efficiency were dominant concerns in its design. What was sought above all was rapidly to restore fiscal income, although there may later appear efficiency and equity costs. At first the results of the tax reform seemed to be very good, and undoubtedly they were in comparison with the revenues (in real terms) collected during the hyperinflation, when fiscal revenues were abnormally low due to the well-known Olivera-Tanzi effect. But later, after this first upswing, collections (excluding the royalties of state-owned companies) remained stagnant at 8 per cent of the GDP, a percentage that is considerably lower than the average in Latin America. Juan Antonio Morales 41

Public sector social expenditure Under the NEP, state mechanisms to protect vulnerable social groups, established after the revolution of 1952, although not fully eliminated have been reduced considerably. Thus, during the first two years of the NEP public sector social expenditure as a share of the GDP underwent severe cuts (Table 2.2). The largest reductions were in education. In healthcare the decrease was considerably less important because international cooperation replaced the lack of national resources. It is estimated that, as of 1988, there has been a sustained recovery of the budget amounts allocated to healthcare and education but definite data are still unavailable. The highly successful Fondo Social de Emergencia (FSE - Emergency Social Fund) should also be mentioned. This fund operated between 1988 and 1990 to see to the problems of poverty, particularly those that arose from the crisis and the problems caused by the adjustment. The most recent government declarations emphasise the need to increase spending in social services. The FSE has been replaced by the Fondo de Inversion Social (Social Investment Fund), which is intended to alleviate poverty through longer-term actions.

Employment in the Public Sector

Prior to the NEP, Bolivia was probably the Latin American country (with the exception of Cuba) that had the largest portion of its urban labour force employed by the public sector. In the first year of the NEP employment in the public sector decreased by slightly over 10 per cent (Table 2.3). However, after the cut in public employment in 1986, it increased again by 1989. The reduction was brought about through lay-offs (euphemistically called `relocations') and resignations due to the very low remunera- tions. The most dramatic case was that of the termination of employment at the Corporacion Minera de Bolivia. This event has been amply documented in excellent studies and does not require further elabora- tion (see, for example, Jette, 1989).

Transparency in Decision Making in Economic Policy

The democratic transition principally implied a change in the political structures and not an abrupt change in the way in which economic policy was formulated. Even with the NEP, which started three years 42 Bolivia

Table 2.3 Employment in the public sector, 1980-9 (number of individuals and indices, 1985-100)

Indices Firms' Government' Total' Firms Government Total

1980 55.193 137.925 193.118 90 75 79 1981 56.643 143.319 199.962 92 78 81 1982 55.888 148.128 204.016 91 80 83 1983 59.718 164.71 224.435 97 89 91 1984 60.851 175.071 235.922 99 95 96 1985 61.514 184.065 245.379 100 100 100 1986 54.827 166.156 220.983 89 90 90 1987 41.327 171.115 212.442 67 93 87 1988 35.846 168.889 204.735 58 92 83 1989 34.731 174.351 209.082 56 95 85

Notes:

1. State-owned and semi-private companies 2. Includes employees working for central administrations, decentralized administrations not included in the companies, diversified; local employees and university employees. 3. Col. (1) plus Col. (2).

Source: Unidad de Andlisis de Politicas Economicas (UDAPE ,1991); Anuario Estadistico, no. 2, La Paz

after democracy had been restored, there was no abrupt change in the way that economic policy decisions were taken. During the transition and for a long time afterwards, economic policy measures were adopted in a manner very similar to common practice during the dictatorship: stipulations were established by means of supreme decrees instead of laws, the boards of directors of state-owned firms and of the Central Bank were appointed according to the will of the executive, and the same was true of relatively important public investment programmes. It should be emphasised that the influence of technocrats during the administrations of Paz Estenssoro and Paz Zamora made them prefer to regulate the economy through decrees instead of resorting to Congress, the procedures of which are slower. It should also be pointed out that the close cooperation between Bolivian specialists and officials of international credit agencies, particularly the International Monetary Fund (IMF), reinforced the political power of the technocrats and also their way of formulating economic policy."' All in all, democratisation has gradually changed the process of Juan Antonio Morales 43

Table 2.4 Private and public gross fixed capital formation, 1980-90 (as a percentage of the GDP)

GDP rate of Public Private Total growth (%)

1980 7.0 7.3 14.3 -1.4 1981 7.2 3.8 11.0 0.9 1982 6.9 6.9 13.8 -4.4 1983 5.0 3.6 8.6 -4.5 1984 4.5 4.0 8.5 -0.6 1985 3.5 3.7 7.2 -1.0 1986 4.8 4.7 9.5 -2.5 1987 6.2 4.1 10.3 2.6 1988 8.1 4.1 12.2 3.0 1989 8.7 4.1 12.8 2.7 1990 8.0 5.2 13.2 2.6

Sources: For 1980-89, World Bank From Stabilization to Sustained Growth'. August, 1991; for 1990, the author's estimates are based on data from the Instituto Nacional de Estadistica. economic policy formulation. In particular, it has forced decision making to become more transparent and it has increased supervision - by Congress and by the public at large - regarding the measures and actions implemented by the executive to stabilise and carry out structural reforms.

2.5 PROSPECTS OF THE NEP

Private Sector Response

The main long-term objective of the NEP is, perhaps, for GDP to grow, propelled by private investment. Although the main macroeconomic balances have been reestablished and despite a highly favourable development policy, private investment has taken a long time to appear. Private investment rates, expressed as a percentage of GDP, were un- usually low between 1986 and 1990 and very similar to those existing during the 1982-85 crisis (Table 2.4). The results, still very preliminary for 1991 (not included in Table 2.4), point to a strong growth of private investment and GDP. However, the question of how sustainable these results will be remains unanswered. Investors, both domestic and foreign, do not seem willing to give 44 Bolivia up their option to wait. In the meantime the highly influential association of entrepreneurs, CEPB, has increased the list of conditions it considers necessary to stir the `animal spirits' of investors. It demands that the government deregulate and privatise all firms that provide services as well as the social security pension funds. The CEPB believes that this last measure is essential in order to develop a capital market."

The Unfinished Task of Privatisation

Privatisation has become one of the central subjects on the agenda of requirements put forth by the private sector (and by international financial cooperation agencies). Now it also occupies a priority position on the agenda of reforms in Paz Zamora's administration. We shall refer to privatisation in the strict sense of the term, as the transfer of public sector property to the private sector.12 The objectives of privatisation, according to the arguments put forth by its proponents, are the same as those observed in international debates. 13 An additional and important result expected by the government is that privatisation will provide more resources for the public sector to invest in social services that do not normally attract the private sector and that might have an effect on growth in the long term. Another objective is given by an argument taken from political economy; that is, an increased dissemination of private property among the population, thereby consolidating the market economy and the NEP as irreversible facts. Many of the arguments against taking privatisation to the utmost are also present in the international debate. The most delicate point, from the political point of view, is its expected redistributional implications. As a result of the fears that these implications cause, privatisation, which appeared to be broadly accepted because it was viewed as a way to fight corruption, in a complete turnaround is now viewed by most political parties and the press as instead having the opposite effect. Paz Estenssoro's approach to privatisation has not been lacking in ambiguities. In his view, the NEP would, above all, help to restore the authority of the state, as mentioned above, and that is why privatisations were not part of the group of essential reforms. Similarly, and only after much reticence, Paz Zamora submitted his privatisation programme to Parliament and managed to have it approved. Privatisation has only recently become a key piece in his reform programme. Contrary to the case of the sale of state-owned companies, to which there is considerable opposition, legislation to promote investments in Juan Antonio Morales 45 crucial sectors such as mining and oil were approved rapidly. The opening up of exhaustible natural resources to foreign capital is quite extensive and greater than in all the other countries in the region.

Private Sector Beneficiaries

Redistributional arguments are not totally absent from liberal reforms. To begin with, the fight against corruption, which is a perverse form of redistribution, is a central issue in Bolivian liberalism. More con- ventionally, it has been argued that although the NEP could transitorily penalise unionised labourers and middle-class civil servants, it would instead favour the poorest sectors - that is, the peasants and workers in the informal urban sector. The data, however, do not support this hypothesis, at least with regard to peasants (Morales, 1991). Who, then, are the main beneficiaries of the NEP? If price stabilisation and an organised way of formulating economic policy brought about by the NEP is considered, then the entire country has gained. If, instead, income redistribution is considered (for which, unfortunately, there are no recent studies), the results are more ambiguous. Available information, albeit not systematic, appears to indicate that, thanks to the NEP, the ones who have benefited above all are the trade and export elites, the holders of financial assets and the high middle classes who have been able to channel the resources of international aid to their benefit.

Political Perspectives

An important point, which is not sufficiently emphasised in debates, is that of the deep changes that the NEP has produced in traditional political parties. Almost without realising it, the parties have abandoned the search for short-term political advantages in exchange for permanent political relevance, even if they are not in government. If they are in government, they are less concerned than before about the possibility of allowing their successors to reap the benefits of their work, which in a way depoliticises decision making in economic matters. This attitude is not so much the result of foresight by party leaders but rather of less uncertainty about the possibility of being reelected in the middle-term, if not immediately. The strongest opposition to the NEP now comes from the anti- establishment populist parties: Union Cfvica Solidaridad (UCS - Soli- darity Civic Union) and Conciencia de Patria (Patriotic Awareness). 46 Bolivia

These political parties have a growing electorate that is in contrast to their unspecific economic platforms, which tend to pick up on dissatisfaction with the current situation and its beneficiaries instead of sug- gesting concrete proposals for change. Their electoral climb is typical of an increasing divorce between the state, conventional political parties and civil society.

2.6 FINAL COMMENTS

The transition to democracy in Bolivia was accompanied by a severe deterioration of the economy. Together with the problems that the first transition government inherited, the need to secure democracy was an additional factor in the crisis. Later on, this hard-won democracy was jeopardised by the worsening of the economic situation. Fortunately, democratic institutions showed greater strength than anticipated in the extremely tight economic circumstances of those years. The 1982-5 crisis explains to a large extent the design of the stabilisation programme of the NEP. Conversely, it is not as easy to conclude that it is the only explanation for the structural reforms. Other factors began to operate, such as convincing political elites that a radical change was needed in the development model. The need to keep on having access to the resources provided by international financial cooperation, in a highly penurious fiscal and foreign exchange situation, was also very important in the adoption of the NEP. The achievements of the NEP regarding modernisation are very significant, but Bolivia's economy and society still have a long way to go. The most urgent needs now are those of social development. This will, in turn, involve more public sector reforms, including reconstitution of government administration. Available information shows NEP reforms as long-lasting, which does not mean that it is not in any danger. The most important peril would be the election of a populist government, especially if there are no fairly rapid concrete results, such as growth in the gross domestic product, employment, or real salaries, and increased access to public services. There is an unfinished agenda of tasks that the political parties supporting the NEP still have to implement if they do not want populist movements to reverse what has already been achieved in terms of modernisation. Juan Antonio Morales 47

Notes

1 . This study received the support of the International Development Research Centre in Ottawa, Canada. The author is grateful for the valuable comments made by Gary McMahon. 2. Hyperinflation and the stabilisation programme defined in Supreme De- cree 21060 have been documented in Sachs (1987) and Morales (1988). 3. Initially the major parties in the coalition were the Movimiento Nacionalista Revolucionario de Izquierda (MNRI, the Nationalist Revolutionary Left- Wing Movement), the Movimiento de la Izquierda Revolucionaria (MIR, the Movement of the Revolutionary Left-Wing) and the Partido Comunista de Bolivia (PCB, the Bolivian Communist Party). A few weeks after the government took office the coalition was extended to include a political party from the centre, the Partido Demdcrata Cristiano (Christian Demo- cratic Party). 4. This analysis is based on the discussion by Capie (1986). 5. Devaluation of the nominal exchange rate should not be accompanied by a corresponding price increase if it is to secure a devaluation of the real exchange rate, which in general implies a drop in real salaries. 6. In the year following the one in which he took office, he imposed mar- tial law on two occasions and constantly exerted political pressure over the labour unions which, although staying within legal bounds, was nonetheless a harassment. 7. This point is made very well by Conaghan et al. (1990). 8. CRDs are regional delegations appointed by the central government that, in principle, enjoy considerable independence in financial and decision- making matters. Although this issue is being debated, it seems increasingly clear that the transfer to the CRDs and municipalities was conceived as an intermediate stage prior to privatisation. 9. This approach, which assumes that the state is, almost by definition, bureaucratic and predatory, is closer to the schools of `public choice' proposed by Buchanan and Tullock (1962), Olson (1982) and others, and to the new political economy' of Bhagwati (1982) and Krueger (1974) than to the Chicago school. 10. Cooperation between Bolivian specialists and international credit agencies was also crucial in providing support for the external credibility of the stabilisation programme, which was as important, or even more so, than internal credibility. 11. A CEPB document dated 8 July 1991: `Why is there not more investment in Bolivia?' The demand for privatisation on the part of the CEPB is not confined to service companies and social security; it also covers all state-owned companies. 12. The liquidation of state-owned companies is not considered as privatisation, but rather as a measure to reorganise the public sector. 13. On the international debate see, for example, Vickers and Yarrow (1991) and Starr (1990). 48 Bolivia

References

Bhagwati, Jagdish N. (1982) `Directly Unproductive Profit-Seeking (DUP) Activities', Journal of Political Economy, vol. 90 (October), pp. 988-1002. Buchanan, J. M. and G. Tullock (1962) The Calculus of Consent (Ann Ar- bor: University of Michigan Press). Capie, Forest (1986) `Conditions in which Very Rapid Inflation has Ap- peared', Carnegie-Rochester Series on Public Policy, vol. 24, pp. 115-68. Conaghan, Catherine M., James M. Malloy and Luis A. Abugattas (1990) `Business and the "Boys": The Politics of Neo-liberalism in the Central Andes', Latin American Research Review, vol. 25 (Spring), pp. 3-30. Confederation de Empresarios Privados de Bolivia (CEPB) (1991) `Porque no hay mas inversion en Bolivia?', mimeo (La Paz: CEPB, July). Instituto Latinoamericano de Investigaciones Sociales (ILDIS) (1985) `La Nueva Politica Economica (Ira. Parte)', Foro Economico, no. 5 (La Paz: ILDIS). Jette, Cristian (1989) De la Toma del Cielo por Asalto a la Relocalizacidn (La Paz: HISBOL). Krueger, Anne O. (1974) The Political Economy of the Rent-Seeking Society', American Economic Review, vol. 64, pp. 291-303. Morales, Juan Antonio (1988) `Inflation Stabilization in Bolivia', in M. Bruno et at. (eds) Inflation Stabilization: The Experience of Israel, Argentina, Brazil, Bolivia and Mexico (Cambridge, MA: MIT Press), pp. 307-60. Morales, Juan Antonio (1991) `Structural Adjustment and Peasant Agricul-

ture in Bolivia', Food Policy, vol. 16, no. 1 (February), pp. 58-66. Olson, M. (1982) The Rise and Decline of Nations (New Haven: Yale Uni- versity Press). Sachs, Jeffrey (1987) The Bolivian Hyperinflation and Stabilization', Amer- ican Economic Review, vol. 77, no. 2 (May), pp. 279-83. Starr, Paul (1990) The New Life of the Liberal State: Privatization and Restructuring of State-Society Relations', in Ezra N. Suleiman and John Waterbury (eds), The Political Economy of Public Sector Reform and Pri- vatization (Boulder: Westview Press), pp. 22-54. Unidad de Analisis de Politica Economica (UDAPE) (1991) Estadisticas Economicas de Bolivia (June). Vickers, John and George Yarrow (1991) `Economic Perspectives on Privati- zation', The Journal of Economic Perspectives, vol. 5 (Spring), pp. 111-32. World Bank (1989) `Bolivia. Public Sector Expenditure Review with Special Emphasis on the Social Sectors', mimeo (Washington DC: World Bank). World Bank (1991) `Bolivia. From Stabilization to Sustained Growth', mimeo (Washington DC: World Bank). 3 Democratic Restoration and Economic Policy: Argentina 1984-91 Mario Damill and Roberto Frenkel

3.1 INTRODUCTION

This chapter describes and analyses the complex problems, restrictions and challenges that Argentinean economic policy had to face from the end of 1983. At that time the military government installed by Videla seven years earlier gave way to the democratic government led by Raul Alfonsin. The study ends in 1992, when under the administration of Carlos Menem, and within the framework of a new stabilisation programme, the Convertibility Plan, the country reached a credit agreement with the commercial banking system, framed within the Brady Plan. The following analysis is based on several earlier studies, the formal details and econometric developments of which have been omitted here. Thus, though this history of the economy and economic policy of Argentina has been developed for the most part on models, the formal structure of these remains concealed behind the curtains, as it were, in order to make this chapter more accessible to the lay reader. The democracy reclaimed by the Argentineans towards the end of 1983 was faced from its inception with a complex array of tasks and challenges. In the first place, there were the issues relating to human rights violations under the dictatorship and the role that would be assumed by the armed forces within the new institutional framework. The tensions, anxieties and conflicts underlying those issues made the extent of the economic problems that lay ahead less easy to predict. The tasks relating to acknowledging and remedying the immediate tragic past, as well as institutional construction and reconstruction, had to be dealt with at the same time as actions aimed at controlling and reversing the acute economic crisis which, it turned out, was not adequately understood. The critical demands that this intricate scenario imposed upon the democratic transition threw a shadow over the relationship

49 50 Argentina between politics and economic policy under the government headed by Raul Alfonsin from 1983 to 1989. The processes and different stages that led to the markedly unstable economic scenario inherited by the reinstated democracy are described in Section 3.2 of this chapter. Section 3.3 examines the diagnosis that the new government (and the leaders of the majority political parties in general) made of the situation. This chapter also offers an evaluation of the strategies followed and the consecutive successes (more or less ephemeral) and failures, the main landmarks of which were the Austral Plan, launched in 1985, the hyperinflationary processes of 1989 and 1990, and the stabilisation plan with free monetary convertibility introduced in April 1991. Finally, Section 3.4 reflects on the design and implementation processes of the economic policies. The central aspects of the Argentinean economic crisis of the 1980s represented an enhancement of its two typical traits since the Second World War. The first was fiscal disequilibrium of such a magnitude that it decisively limited the possibility of state regulation of the economy: traditional instruments of economic policy became inadequate and impossible to utilise under the new circumstances; and the public sector and the capabilities of administrative management suffered a progressive and visible deterioration, owing to the fact that different attempts to attain fiscal adjustment were based on emergency measures that failed to pay due consideration to efficiency and equity. The second trait relates to the weak web of internal financial relationships, the fragility of which increased considerably. The economy became demonetised and was dollarised. Both traits owed much to the country's indebtedness and the burden of the external debt payments, especially after 1979. The fiscal and public management crisis and the internal financial disintermediation affected the economy's long-term trends and its short- term dynamics. Because of their negative effects on investment finance, they became important roadblocks to the recovery of growth. In addition, stabilisation policies' margins for action were substantially restricted by the need to finance the public sector in cramped domestic financial market conditions. The deterioration of the state cannot be perceived, however, as resulting from the policies of liberalisation and economic openness pursued by the military government from the end of the 1970s: several of the substantial institutional changes brought about in those years (especially the financial reform, the exchange rate and tariff reforms and the norms relating to the operation of labour markets) were abandoned in 1981-2. The crisis had compelled the Mario Damill and Roberto Frenkel 51 authorities to resort to foreign exchange controls once again, to re- instate the regulation of interest rates and to exclude external competition from the goods markets. The profound crisis that stunted the liberalisation and openness attempt gave rise to a sort of disorderly retreat of the state, which progressively lost its capacity to intervene and arbitrate and frequently developed inconsistent policies. During the last year of military administration (1983) the economic authorities tried to prevent the situation from becoming completely out of control before the change of government. There were no new policy options for an administration whose days were numbered, especially because of its politically devastating defeat in the Falklands War, other than restoring constitutional democratic mechanisms. Economic policy was limited to preventing the transition from taking place in a context of greater disorder, which would only magnify the loss of power of the armed forces. At the same time, however, some sectors within the authoritarian government acted somewhat independently in an attempt to attain a less traumatic transition. It was believed that an alliance with sectors of Peronism, seen as certain winners in the coming elections, could result in a cloak of silence falling over the recent past in matters of human rights violations. There were, for instance, important nominal wage increases throughout 1983, promoted by the authorities of the Ministry of Labour, as a result of the strong association of Peronism with the trade unions. This development helped provide Alfonsin with a strong element in his electoral campaign, allowing him to denounce the 'military-trade unionist pact'. During the whole of the second half of the 1980s Raul Alfonsin's government was able to hold back and partially reverse, though only in a transitory manner, some of the economic deterioration of the preceding phase. Successive stabilisation plans were destroyed by the persistence of the basic macroeconomic disequilibria (external and fiscal) combined with the pressures deriving from the intense labour- capital struggle over income distribution and, in some cases, problems in the design of the policies. The attempts at stabilisation through shocks had increasingly more ephemeral results and towards the end of the 1980s the economy was out of control. The deregulating and privatising sermon was taken up again by the state in the last years of the decade. However, far from making progress in an orderly reform of the public sector, it seemed that the disorderly retreat gained in tempo, either because `emergency prevailed over reform' or due to the increasing influence of a simple-minded neoliberal 52 Argentina conception of the role of the government combined with the pressure exerted by the international financial institutions. The first hyperinflation, in February 1989, was the epilogue of the administration of the Radical Party. This event significantly altered the political and economic panorama. It was an important source of new economic behaviour and a redistribution of political power. The new phase was highlighted by the ideological turnabout of Peronism under the leadership of Carlos Menem. At the beginning of the 1990s, during the new Peronist administration, some developments took place in matters of structural reform, especially with respect to privatising state-owned enterprises and economic liberalisation, in line with the so-called `Washington consensus'. Despite many procedural shortcomings, it is undeniable that the government managed to build, using the first privatisations as examples, an image of relative efficiency, which enhanced its political capital. This reinforced some degree of consensus, as the hyperinflation experience had modified the priorities of society, placating or weakening any demands that were not related to that of stability. At least temporarily, these factors increased the freedom of action of economic policy. The fall in international interest rates and some reversal in capital flows at the beginning of the 1990s (which for the first time since the debt crisis alleviated the burden of external restrictions on several Latin American economies) operated in the same direction. These factors contributed to the initial success of the stabilisation plan, which was based on the free convertibility of the domestic currency, launched in 1991. At the beginning of 1992 Carlos Menem's administration reached an agreement with the commercial banking system, rescheduling the debt within the framework of the Brady Plan. There were those who said that the `crisis of the debt' was coming to an end, ten years after the moratorium on external payments by Mexico. Certainly, and even though an excessive proximity can distort the analysis, it is highly likely that this vision was excessively optimistic. Even though the recent attainments of economic policy, in terms of greater stability in particular, have been significant, there are a number of fragile characteristics. Moreover it is not clear that the path to growth will recover spontaneously. The investment rates displayed by the Argentinean economy are extraordinarily low: on average approximately 11 per cent of GDP in the second half of the 1980s, with a minimum of 8 per cent in 1990. Even though, in the very short term, the more optimistic expectations in matters of stabilisation have been fulfilled, the generation of an additional savings effort that is necessary to re- Mario Damill and Roberto Frenkel 53 cover reasonable and sustainable rates of economic growth remains a serious challenge for Argentinean society and its present and future governments. 1

3.2 BACKGROUND

Accumulation with Financial Repression

The effects of the serious foreign exchange and financial crises of 1980-1 were extremely important in the determination of the economic scenario of Argentina in the 1990s. Many of the problems of the 1980s and 1990s were due, however, to structural problems associated with the previous economic model of import substitution, which was exhausted by the mid-1970s. A quick review of this model of heterodox capital accumulation is, accordingly, essential for a full understanding of the situation inherited by the civilian government in 1983.2 The assertion that the pattern of accumulation, dominant in the postwar Argentinean economy, went through a deep crisis in the mid-1970s seems beyond dispute. Based on the process of import substitution industrialisation (ISI), it had shaped a semi-closed economy, with a protected and strongly oligopolistic industrial sector and an undynamic agricultural export sector. It is important, however, to point out some qualifications of this predominant evaluation by discussing some nuances on the thesis of an exhausted strategy. A first noteworthy fact is the rate of growth of the Argentinean economy in those years. Between 1964 and 1974 GDP increased on average by 3.5 per cent annually, and over the period 1946-74 was higher than 4.5 per cent without a single year of recession. While this is a relatively poor performance compared with that of either the Asiatic tigers or Brazil over the same period, it contrasts distinctly with the stagnation that was to follow. Secondly, economic expansion was supported almost exclusively by internally generated savings. The external resources absorbed by Ar- gentina were of little significance. Throughout the entire 1961-75 period investment was close to 20 per cent of GDP, while average external savings only reached 0.3 per cent per annum.3 These figures conceal, however, the fluctuating character of the balance of payments. In fact the basic structural disequilibrium of the economy lay in the inability to generate enough foreign currency to maintain full utilisation of its productive capacity, giving rise to a cyclical dynamic, which has been 54 Argentina formalised in the so-called models of `stop and go'. A stylised description of the cycle goes as follows. In the phases of economic expansion imports grew strongly, due essentially to the dependence of local industry on imported inputs. Exports, mostly agricultural, were by contrast relatively stagnant. Thus sooner or later the trade balance began to show a deficit. When the reserves of the Central Bank fell below critical levels it was time for traditional adjustment policies of the sort recommended by the IMF: devaluation to favour the transfer of resources to the producers of exportable goods or those substituting imports and a reduction of internal spending to `liberate' resources that could be used in the production of export goods. It is important to point out that, in contrast to the situation after the debt crisis, the traditional adjustment policies recommended by the IMF, though costly in terms of GDP and employment, were able to correct the external disequilibrium with some degree of expediency. Since the balance of payments deficit actually reflected an excess of internal spending over national revenues, the reduction in spending managed to restore equilibrium without much help on the export side. After having recovered the foreign currency reserves, the economy was in a position for a new phase of expansion. According to the stylised version of the cycle, the wheels of recovery were a new change in prices (with a subsequent reversal in the distribution of income), in this case in favour of the urban sectors, through an increase in nominal wages and of industrial prices relative to the exchange rate. The economy thus showed an inflationary bias associated with the processes of change in relative prices and the redistribution of income among the sectors throughout the cycle.' The short-term macroeconomic instability derived from the foreign exchange gap and the alternating phases of `foreign exchange inflation' and `wage inflation' (and of industrial prices) appears then as an inherent characteristic of the Argentinean economy in the postwar period. The source of instability generated by the poor performance of the external sector was, however, attenuated towards the end of the 1960s. From 1964-74 the economy expanded without facing any balance of payments crisis comparable to the preceding ones.-' Even though the balance of payments showed a relatively favourable long-term trend, at the fiscal level tensions and problems were accumulating, related in particular to the forms of financing capital accumulation that characterised the model. The state played a central role in generating savings as well as in allocating them. Investment was financed more through mechanisms of compulsory saving and trans- Mario Damill and Roberto Frenkel 55 fers of financial wealth among sectors (the so-called `inflation tax'), rather than through voluntary market transactions. The existence of interest rate regulations, managed loan mechanisms and foreign exchange controls constituted a regime of `financial repression' that, in conjunction with state manipulation of prices, defined the heterodox character of the accumulation model. It must be emphasised that the central role of the state in investment and the generation of political 'quasi-rents' favoured the development of corporative patterns in negotiating demands, especially in relation to the distribution of those rents and by the emergence of networks of common interests between the private productive sectors and segments of the public bureaucracies. For example, trade unionism was strengthened due to the ability of labour to participate in the rents of protected industry. These alliances would strongly influence the results of subsequent phases.

High Inflation

In 1975 the Peronist government was undergoing its final crisis. The death of Juan Peron in mid-1974 resulted in the collapse of the precarious political equilibrium he had painstakingly built. His followers en- gaged in an intense struggle for his succession, with devastating effects on the operation of the government. The `Rodrigazo', an attempt to bring about a strong real devaluation and increase public prices in order to correct the disequilibria of the balance of payments and fiscal accounts, coincided with that serious political crisis and met intense resistance from the wage-earning sector. The resulting acceleration of inflation marked the inception of a new stage. The nature of the inflationary process underwent a transformation. Henceforth, only on two occasions, in 1980 and 1986, was the inflation rate to fall below 100 per cent until the Convertibility Plan of 1991. The persistence of very high rates of inflation over a prolonged period led to the development and extension of practices, institutions and mechanisms based on expectations of their continuation. The high inflation regime in Argentina was characterised by a structure of contracts in which automatic indexing to past inflation were predominant and a high degree of coordination between agents and markets and between contract systems and the mechanisms geared to the formation of expectations. Under high inflation, contracts in nominal terms tend to disappear or prevail for very short periods, as happens with deposits 56 Argentina in the financial system. In the case of transactions conducted in the goods, services and labour markets, indexation rules appear as a form of reducing costs of renegotiation and conflict resulting from the establishment of nominal contracts that need to be reviewed very frequently. The short-term macroeconomic dynamics in a high inflation regime differ from those in other economies. With generalised indexation the inflation of one period would tend to equal that of the preceding period in the absence of shocks. Indexed contracts `carry over' past inflation to the present one, bringing inertia to the system. However the shortening of the readjustment periods of indexed contracts affects inflation in that it gains volatility. That is, it becomes more variable since the effects of the shocks (a nominal devaluation, for instance) are transmitted rapidly to the whole of the price system. Accordingly the set of norms and practices resulting from the defensive microeconomic behaviours produce a global result of greater economic instability and uncertainty. Although short-term instability was a characteristic trait of the Argentinean economy in the heterodox phase of accumulation, the high inflation regime created conditions under which the intensity of macroeconomic fluctuations were even greater.

From Financial Liberalisation to the Crisis

In 1976, after a military coup d'etat that ousted Isabel Peron, there began an attempt to bring about a radical change in the operating conditions of the Argentinean economy. The semi-closed development model and the dominant role of the state in resource allocation and income distribution were challenged on many fronts. The nationalist-interventionist bias of the military and their traditional resistance to the liberal criticisms of the heterodox model capitulated in the face of the conviction that the existing model had created the conditions under which political and social subversion were nurtured at the end of the 1960s. The economic plan was to give markets the central role in resource allocation. Thus it was intended (at least in discourse, since actual practice was often quite different) to reduce the role of the state in defining `political quasi-rents' in favour of protected industry and wage- earners, to dismantle the financial repression regime and to open the economy to external competition. The policies applied initially did not depart, however, from the characteristics of the traditional adjustment plans, except for the highly regressive income distribution brought about in 1976. The brief phase Mario Damill and Roberto Frenkel 57

1976-77 had one essential characteristic: rather than a drastic change in the economic model, a recomposition of the conditions for the operation of the previously prevailing model was undertaken. The performance of the external sector improved remarkably, as did the fiscal situation. Inflation, however, continued to persist. Nevertheless the economy seemed to be on the road to recovery, given the improvement in the basic macroeconomic disequilibria. However a policy of gradual reforms was not on the agenda of the regime. On the contrary, they wanted to change even more radically the conditions under which the economy operated. 1979-81 marked the second decisive stage of the military government. There was an attempt to stabilise based on the monetary approach to the balance of payments, the failure of which would leave an indelible mark on the future course of the economy.' The problem that the indexing practices caused for stabilisation policy was explicitly acknowledged in 1978 by the economic authorities. An attempt was then made to do away with indexed contracts and mechanisms leading to the formation of expectations as a function of past inflation. The authority chose not to intervene directly in contracting practices. Price setters and wage-earners were to be disciplined by an accelerated trade liberalisation, which would lead to an increase in competition. With `real' liberalisation and the pre-setting of the rates of devaluation for each month in a decreasing sequence, internal inflation would tend to equal international inflation.' A crucial timing problem arose in relation to the stabilisation policy. For several months inflation rates were substantially above the preset devaluation rates, bringing about a very significant overvaluation of the domestic currency. While the `disciplining' of price setters and wage earners progressed very slowly, a new element, which would be decisive because of its long-term effects, appeared with a vengeance on the economic scene: the international movement of capital. Under the heterodox model of accumulation, exchange rate policies had been oriented towards trade account (or current account) goals; capital movements were limited and were normally subject to restrictions. The change was drastic when the exchange rate was used as a stabilisation instrument instead of for current account objectives. It was expected that the latter would experience some initial deterioration as a result of trade liberalisation, but the international financial markets would guarantee the financing of the disequilibrium through the capital account of the balance of payments. At first the arbitrage mechanisms rapidly equalised domestic interest 58 Argentina rates (plus the preset devaluation) with nominal international rates. But the persistence of inflation resulted in negative real rates, whereby internal and external indebtedness was encouraged and the Central Bank accumulated reserves throughout 1979. Towards the end of that year the already notorious overvaluation of the domestic currency seemed to make indebtedness in dollars increasingly more risky, which was reflected in the increase of internal interest rates to positive real levels. By then some local productive sectors already faced liquidity restrictions, brought about by declines in sales owing to the competition of imported products. The progressive aggravation of this situation led to the financial crisis of March 1980, caused in part by a large portfolio of bad loans from banks to other firms. Expectations of a discontinuation of the exchange rate policy were becoming stronger as time went by and brought about a reversal, in mid-1980, of the direction of capital flows. The government carried out a number of actions aimed at maintaining the current policy, which would have very serious future consequences on public finances and the balance of payments. On the one hand, a greater external public indebtedness was unavoidable. The state-owned companies substituted external for internal credits in order to reduce pressure on the declining reserves of the Central Bank. In the meantime the Bank issued rediscounts to support banks that were losing deposits. Due to lack of confidence in the sustainability of the policy, this monetary increase was feeding the foreign currency run. The overvaluation of the domestic currency and the increasingly negative expectations finally led to a bank run that was impossible to stop and the policy of preset devaluations was abandoned in February 1981.' The operation of the economy changed drastically as an outcome of this denouement; but in a direction quite different from the one intended by the military government. In the period immediately before the crisis of 1980-1 certain elements specific to the way of practising politics during the authoritarian period became quite clear. The regime moved to `rid itself' of the social bases that had supported the military coup and to position itself in a certain way over and above the society it attempted to govern (though, ironically, it could not rid itself of the intramilitary conflicts in the midst of the branches of the armed forces and among different groups within them), and attempted the drastic change in the operation of the economy described above. Eventually it was left in a state of utter isolation. However the opposition of broad social sectors did not compel the regime to review its policies, even in this scenario of increasing isolation. To the contrary, months before Mario Damill and Roberto Frenkel 59 the crisis the dogmatism was strengthened by ascertaining that `all sectors are complaining alike'. It seems likely that this rigidity granted the policies applied at the time a greater persistence than they probably would have had in a political context more open to the demands of society. This may have led, in turn, under the conditions then prevailing, to greater distortions, nurturing the violence of the crisis to follow. The crisis of the policy of the tablita initiated the final phase of the military government, the so-called stage of `chaotic adjustment', lasting from 1981 to 1983 - that is, until the beginning of the transition to democracy.1' It was in this phase that the severity of the economic crisis, combined with the increasing political weakness of the military government, extraordinarily aggravated by its defeat in the Falklands, led to a growing lack of control over the economy. Operating within narrow margins, economic policies were dominated by two basic elements: first, by attempts to restore the balance of payments equilibrium by means of strong devaluations and a number of other mechanisms, many of which resulted in massive subsidies to the private sector. Second, actions were undertaken to reduce the over-indebtedness of important sectors of private firms, which had resulted from the previous phase and were aggravated by the effect of the devaluations on their debt positions in foreign currency." Both sets of policies had very negative repercussions on public finances. The Central Bank had to bear great losses as a consequence of the policies of subsidising external private indebtedness as well as internal private credit. On the other hand, the tariff shocks that were used to alleviate this problem, combined with the massive nominal devaluations, exacerbated the inflationary pressures, permanently placing the economy on the brink of hyperinflation. The economy became demonetised and the duration of indexed contracts became shorter, with a generalisation of the practice of monthly indexation.

The Economic Inheritance of Democracy

The external and fiscal disequilibria inherited by the democratic government contained some novel features as a result of the frustrated attempt at liberalisation and the disorderly adjustment that followed. The balance of payments underwent a structural change. As a consequence of the new and very high levels of indebtedness of the country and of the increase in international interest rates, the current account was in a state of chronic deficit despite the important improvement in the performance of the trade account. It is important to stress that the current 60 Argentina account deficit, unlike the transitory disequilibria that were characteristic until 1975, did not originate from an excess of domestic absorption over national income. As already stated, the counterpart to the strong public and private indebtedness from 1978-81 was mainly the capital outflow. While the returns the residents received on their external assets are not computed in the national accounts (nor subject to any control or valuation) interest on the external debt became an enormous burden on the balance of payments. Unlike the disequilibria in flows (income spending), which the traditional adjustment policies reverted rather expediently, this disequilibrium, as it resulted from the maladjustment between the debt stock of the country and its capacity to generate foreign currency (that is, a stock-flow disequilibrium), could not be corrected by reducing domestic spending. Thus adjustment programmes of the type recommended by the IMF were inadequate under the new circumstances. Despite the important improvement attained in the current account, the incomplete external adjustment caused a permanent excess demand for foreign currency, as well as an accumulation of delays in external payments. Due to the contraction of the external financial flows, especially after 1982 as a consequence of the Falklands War and the Mexican crisis, this disequilibrium could not be financed through voluntary loans from creditors. The new `forced' financing from the international banking system, besides that obtained from the multilateral agencies, was expressed by an increase in external savings after 1980. Starting from very low levels, external savings averaged 5.1 per cent of GDP in the period 1981-3, and more than 4 per cent yearly during the 1980s. Stabilisation of the exchange rate in this context was extremely difficult. The problems with external payments and the frequent negotiations with the creditors constituted a permanent factor of uncertainty. In a dollarised economy the gap between the official rates of exchange and the rates in the parallel markets became a sensitive barometer of changes in opinion, reacting to news and rumours, and reducing the leeway of the Central Bank with respect to monetary policy and the management of exchange rates. The problem posed by transfers of real resources abroad to pay interest on the debt was compounded by the `domestic transfer' problem. This can be described succinctly as follows. Even though the bulk of the interest on the debt was a burden on the fiscal accounts, the foreign currency required to meet the corresponding payments, or part of them, were generated by the private sector. Therefore, the state needed Mario Damill and Roberto Frenkel 61 resources (originating from taxes, for example) to purchase foreign currency from exporters, or had to obtain it in exchange for financial instruments in the form of public debt or currency. Each one of these possibilities offers problems of its own. To place internal debt is cum- bersome in a context of acute uncertainty and of marked preference for external financial assets. Within such a context, the interest rates required to absorb the public debt in a voluntary form from the private sector are very high. On the other hand, changes in the money supply affect foreign currency markets and generate inflationary pressures. The additional tax burden needed to cover the disequilibrium of public finances presents, in turn, difficulties of a political nature and creates incentive problems. The policies followed from 1981-3 used varying mixes of the above three policies. A more permanent solution to the problem of fiscal financing was attempted, but the progressive loss of strength and ability in administrative management by the military government, especially after the Falklands conflict, aggravated the situation. The basic economic data at the moment of the democratic transition were as follows. GDP for 1983 was practically the same as in 1975. However national income was far below that of 1975. While in 1975 the GDP/national income ratio was 99.2 per cent, in 1983 it had fallen to 90.2 per cent. 12 Total gross investment was 25 per cent below that of 1975. National savings, which in the 1970s averaged 21 per cent of GDP, had fallen dramatically to less than 11 per cent. The fiscal deficit for 1983 was equivalent to 15.6 per cent of GDP, the highest figure on record, higher even than the 15.4 per cent in the chaotic year of 1975. The average monthly rate of inflation in 1983 was of the order of 15 per cent, but it showed an important acceleration in the last months of the year. The degree of monetisation of the economy had declined enormously. Total private monetary assets slumped from 28.4 per cent of GDP in 1980 to 11.2 per cent in 1983. MI/GDP was 3.8 per cent, so the fiscal deficit was four times greater than the amount of bank notes and coins plus current account deposits in the hands of the public. On the other hand, despite the favourable balance of trade of more than US$3.3 billion dollars, the current account in 1983 had a deficit of US$2.4 billion due to the interest burden. The interest payments/exports ratio, which up to 1979 had remained below 15 per cent, was 69 per cent in 1983. Net external debt was equal to slightly less than 70 per cent of GDP, and the corresponding financial payments to serve the debt equalled 8 per cent of GDP. On the other hand, in the months prior to the inauguration of the 62 Argentina

new government an important change was taking place in some distributive indicators, though this was not adequately realised at the time. At the beginning of 1984 real wages (in the industrial sector, in particular) reached a relatively high level. They had, in fact, recovered, with an acceleration in 1983, the average levels of 1974, the best year of the Peronist government. The real industrial average wage in 1984 was 46 per cent above the corresponding one for the period 1976-83. Besides, as we have already noted, the practice of nominal readjustments through a more or less `automatic' monthly indexation to past inflation was deeply rooted in the labour market. The combination of indexation and wage recovery narrowed the freedom of action of the new government and the possibilities of negotiating with trade union leaders. The latter were, to some extent, compelled to demand something more than wage adjustments determined by indexation, whereas the high inflation forced the government to try to deindex the basic prices in the economy.

3.3 THE PROBLEMS OF ECONOMIC ADJUSTMENT IN A DEMOCRACY

From Optimistic Diagnosis to the First Failure

To this point we have described the acute structural disequilibria, short- term instability and high degree of uncertainty characterising the Ar- gentinean economy after the crisis and the chaotic adjustment at the beginning of the 1980s. In 1983 there were intense demands from different social sectors - which were added to the effects derived from successive policy shocks - to recover income and offset, at least in part, the losses in wealth at both household and firm levels. Despite the serious difficulties and restrictions facing economic policy, the predominant diagnosis in the period preceding the return to democracy, especially within the popular sectors, was optimistic. In the face of such optimism and expectations of distributive reparation, the economic policy proposals initially put into practice turned out be dramatically ineffectual. It was assumed that the difficulties would be manageable on the basis of the political capital a democratic government would have from the outset, both internally as well as at an international level, the latter by virtue of the `Argentinean reinsertion in the world'. For instance it was widely believed that the problem of external indebtedness could be considerably alleviated by combining two elements: Mario Damill and Roberto Frenkel 63

a favourable attitude of the governments in the north towards the new democracy and a less concessional negotiating position than that taken by the military regime. There existed, in general, hardly any knowledge of the inherited structural problems in fiscal matters, and it was also believed that the restrictions were not such that they would prevent the economy, reoriented towards the internal market, from evolving favourably. The aspiration was to attain economic growth with a redistribution of income towards the sectors that had suffered most in the previous phase within a framework of greater economic stability. On the other hand, many of the political conditions that had made Ratil Alfonsin's electoral success possible contained difficult challenges for the performance of his government. Authoritarianism was yielding its power without any accord with the civilian sectors on the return to constitutional normality. As a result democratic leaders were free from any commitment, though at the same time they were bearing the burden of the legacy of the unresolved matter of human rights violations during the dictatorship. Moreover the interpretations of the results obtained by both winners and losers in the elections did not facilitate the process of reaching agreements that would help alleviate the arduous tasks of the transition. Among the Radicals there were erroneous interpretations of the sense of their triumph and the power remaining in the hands of Per- onism was underestimated. The perception prevailing was that the electoral failure of Peronism was their swan song and the end of an era in Argentinean politics. In effect, the temptation to prepare the formation of a new and great and lasting political force under the leadership of Alfonsfn was dominant, overriding any willingness to forge new political accords. An important legislative initiative, introduced at the beginning of 1984, aimed at renewing trade union structures, was part of that strategy, over and above its legitimate justifications. The reform proposal was to serve as an instrument to ensure that the new political force they wanted to build would have a trade union foundation of some importance. Within Peronism, the impact of the bitter electoral defeat aggravated the crisis of the 1970s set off by the death of its founder. Struck by the offensive launched by the government, it tried to coun- teract by recomposing its ranks and preserving its identity, accentuat- ing its profile as a party of the opposition. The resistance to the trade union reform, which was to be eventually successful, became in this way the political banner for Peronism as a whole. 64 Argentina

At the level of the economy, the most immediate problem of the new administration was to contend with a monthly inflation rate of about 20 per cent. After an initial movement based on an incomes policy, centred on the setting of decreasing adjustments of the basic prices in the economy (exchange rates, tariffs, wages, rates of interest), which failed after a few months, the government followed a line of economic management that was more palatable to the populist tradition of the party. The ascending trend of wages was maintained, GDP expanded moderately as a result of consumption growth, while investment continued to fall. The fiscal deficit remained over 12 per cent of GDP. The initial policy of the government, which failed to cope with any of the domestic structural problems and was quickly frustrated in its hope for a successful external renegotiation, came to an end in Sep- tember 1984. It was followed by an IMF-inspired devaluation and tariff shock, accompanied by a strong monetary restriction. This orthodox package generated the usual results of this type of policy, although of a greater than usual intensity due to the magnitude of the disequilibria. It led to a new acceleration of inflation, a drop in wages, demonetisation and an intense and rapid contraction of economic activity. The fiscal situation did not improve to the extent expected because the reduction in public spending that took place as an outcome of the fall in real wages, the payment of pensions and of military disbursements, was in part compensated by the negative effect of the inflationary acceleration and the recession on real tax collections."

The Austral Plan and the Erosion of its Initial Results

The orthodox stabilisation attempt at the end of 1984 was not only costly in GDP terms and in intensifying the degree of social and economic conflict, but it was also extremely ineffective. The increasing lack of control over the economy led the government to attempt stabilisation through a complex shock programme launched in mid-1985, the Austral Plan. This plan did not attempt to intensify the balance-of- payments adjustment, but fundamentally to recover some internal equilibria and part of the government's margin for action in economic policy. The plan had a strong component of incomes policy, as would subsequent stabilisation attempts made by the Radical government and Menem's government. These were combined with a set of fiscal and monetary measures.14 The incomes policy consisted in freezing the basic prices in the economy (exchange rates, tariffs, wages, industrial prices)." Mario Damill and Roberto Frenkel 65

This first component of the Austral Plan was aimed at breaking the inflationary inertia by discontinuing the practice of indexing to past inflation. Its objective was also to serve as an instrument in coordinating the decentralised decisions of private agents, by increasing the degree of confidence of each agent in relation to the behaviour to be adopted by the others as a response to the shock. That is, it aimed at rendering more credible the assumption that to follow the guideline of `zero inflation' set by the government would not bring about strong losses since competitors, suppliers and so on would be induced by the authorities to adhere to the same line of action. This policy was the axis of anti-inflationary action, but it could only be sustained by fiscal and monetary behaviour very different to that observed in the preceding period. The fiscal deficit and growth of the money supply had to be sharply cut. Thus the government committed itself not to issue any additional money to finance the disequilibrium of public accounts. The change of the monetary unit and the establishment of a conversion table from the old to the new currency made it possible to avoid the strong transfers of wealth from debtors to creditors that would have taken place due to the high nominal interest rates prevailing at the time. Regulated rates of interest were set initially at 4 per cent monthly, far below previous levels. In addition, a series of fiscal measures were addressed. Taxes on foreign trade were increased and a tax reform was drawn up to be submitted to Congress. These changes, added to the expected improvement of tax revenues resulting from the decline in inflation (the `reverse' Olivera-Tanzi effect) would bring about a deficit, according to initial forecasts, of about 2.5 per cent of GDP towards the end of 1985. The third component of the package involved external negotiations. If successful, the expected fiscal deficit would be compatible with the availability of financing from abroad, whereby the state would not require any additional internal financing. Even though some sectors rejected the plan from the very beginning (especially the trade unions), the public, in general, showed favourable expectations and confidence. The deposit certificates in the financial system were renewed, the dollar in the parallel market fell, and the price freeze was abided by without there being any need for significant coercive action from the government. The impact-effect on inflation rates was large, especially with respect to industrial prices, which fell to monthly rates below 1 per cent. The decline of inflation permitted an important recovery in monetisation. The M1/GDP ratio doubled over a period of nine months, reaching close to 6 per cent. In addition, the 66 Argentina fiscal deficit went down substantially. The state recovered a certain capability to conduct monetary policy. Despite the fact that the political opposition and trade unions deemed the plan recessive, there was an accelerated recovery of the levels of industrial activity, pushed to an important extent by the improvement in purchasing power of real wages. Manufacturing production expanded by about 20 per cent in the twelve months following the shock. An incipient recovery of investment was also observed. In comparison with the frequent and aborted orthodox stabilisation attempts preceding it, the Austral Plan was much more effective in controlling inflation and also avoided the strong costs in terms of declines in GDP and employment, demonetisation and financial disintermediation. It also had important political effects. The plan faced opposition not only from the traditional sectors of Peronism, but also from a faction of the Radical Party, who did not conceal their annoyance with respect to formulas that departed from the classical distributive pattern. In part as a response to this situation, but also as a consequence of the initial success of the economic policy, the `Alfonsinist' current within the party adopted a more distinct identity that involved distancing itself somewhat from its own party. In any event, owing to the economic attainments of the government the party was able to cope favourably with its first electoral test. In the November 1985 elections for a partial renewal of the Chamber of Deputies, the Radical Party received 43 per cent of the votes, against 34 per cent for Peronism. This result, a new setback to an opposition already having trouble with its identity, strengthened the confidence of Alfonsin's administration and consolidated the trend towards what has been called the phase of the `president's government', in contrast with the previous one, which had been characterised by a greater relevance of the party." The manifestation of this new cycle would be marked, among other things, by the introduction of institutional initiatives of great repercussion, such as the reform of the constitution and the relocation of the capital of the republic to the south of the country.

The persistence of inflation Even though inflation fell substantially, consumer prices continued to increase at an average of between 2 and 3 per cent monthly, despite the effective freezing of industrial prices. The increases became concentrated in sectors difficult to control, such as some services and `flexible prices' markets such as fresh foods. Relative prices were modified Mario Damill and Roberto Frenkel 67 progressively in favour of these kinds of goods. Even though the increases were slight in comparison with the inflationary rates the economy had previously suffered, the `residual' inflation contributed to a reactivation of the indexing mechanisms. In fact the results of the Austral Plan were eroded by the persistence displayed by the prevailing high-inflation regime. It is not simply a phenomenon of inflationary memory associated with the process of the formation of expectations, but also of the inertia of the defensive practices, the norms and institutions developed throughout a protracted period of high inflation as a response to a context of uncertainty. Only a few months after the inception of the plan, this persistence could be observed mainly at two levels. First, financial contracts continued to be very short term, in general having a maturity of not more than one month (and mostly with a maturity of seven days). Second, in the labour market the practice of automatic wage adjustment was rapidly renewed, with indexation to past monthly inflation, despite the successful freezing of industrial prices. It was ascertained then that the relatively low rates of inflation observed throughout a period of several months, accompanied by a non-expansionary fiscal and monetary performance, did not prove to be enough either to transform those practices or even to extend the periods of readjustment of contracts. An examination in retrospect leads one to the conclusion that there is a very low probability of reversing a high inflation regime by means of decentralised negotiations, especially in a period of economic expansion. A more intense coordinating action from the government would have required a better ex-ante evaluation of this phenomenon, which was only adequately perceived when the rates of inflation had already begun to increase again. The persistence of the high inflation regime explains the speed and violence with which the economy responded in the face of the loss of the initial gains of the programme.

The unfavourable external shock Despite the importance of the domestic factors mentioned, the greatest pressure on the programme came from the external sector of the economy. The balance of payments situation rapidly deteriorated in 1985 as a consequence of a combination of factors, the most predominant being the strong worsening of Argentina's trade conditions. During the first four years of the Radical government, the terms of trade with the rest of the world experienced a fall of nearly 40 per cent, concentrated in 1985-6. In addition, there was a decrease in the physical volume of 68 Argentina agricultural exports, due to the price-effect but also as an outcome of the great floods in the pampa region. As imports tended to increase due to the economic recovery, the balance of trade had a deficit in 1986 that was 55 per cent higher than in 1985, and the current account displayed the highest deficit since 1981. The deterioration would become more acute in 1987, a year in which the current account deficit of the balance of payments exceeded $4.2 billion. Within this context, the pressures the livestock and agricultural sector put on the government for a higher real exchange rate and a lower tax load became especially impassioned.

The increasing pressures on the stabilisation plan Throughout 1986 the stabilisation plan, which had been progressing quite favourably, was submitted to strong sectoral pressures. In view of the relative political isolation the government faced and the low enthusiasm for the stabilisation policy within the Radical Party itself, attempts were made to open up negotiations to diminish sectoral pressures, in many cases involving going beyond the margins and requirements of the anti-inflationary programme. The government seemed to be quite confident in its ability to cope with the current economic situation. This made it assume that it would be possible to absorb some concessions without compromising the policy as a whole, and that (ad hoc) countervailing measures could be adopted when needed. First, the government tried to dampen the impact on the domestic economy of the unfavourable change in external conditions by preserving the level of activity and income of the private sector, especially the export sectors affected by declines in international prices and by floods. This was done at the expense of a greater fiscal deficit. Taxes on traditional exports were reduced, while those on industrial exports were increased. The consequent negative impact of the external shock on public accounts clearly revealed the fragility of the fiscal adjustment. From a deficit of 11.9 per cent of GDP in 1984, it had decreased to 6 per cent in 1985 and 4.7 per cent the following year. This was the lowest deficit since 1971 and was a striking achievement within the context of the serious economic difficulties under which it occurred. It was obtained to a great extent, however, by following the lines of least resistance, regardless of considerations of efficiency and equity. The adjustment concentrated on short-term flexible disbursements, such as wages and pensions and maintenance costs. While tax, tariff and budgetary subsidies Mario Damill and Roberto Frenkel 69 to private enterprises were less affected (or continued to increase), expenditure related to some large public works contracted. Suppliers to the state, protected by both a difficult-to-remove legislation and the ability to protect themselves through high mark-ups, were affected to a much lesser degree by the austerity measures. The adjustment was more equitable with respect to revenues. Tax revenues increased by more than 6 per cent of GDP, substituting for the indiscriminate burden of the inflationary tax. 17 The fragility of the fiscal adjustment also stemmed from the fact that emergency instruments (such as the `compulsory saving' mechanisms applied on several occasions) were not replaced by more permanent forms of financing. There were also no visible developments in tax administration to reduce evasion, which continued to grow. It must be pointed out that the attempts at tax reform ran up against the legislative blockade of Peronism, in which even the spokesmen of the `renovated' sector, much closer to the government's positions, adopted in public an attitude of open opposition to the stabilisation policy and resorted to populist arguments. Peronism also systematically opposed reductions of subsidies for industrial promotion and sought to swap the government's tax initiatives for greater contributions from the state to the provinces governed by representatives from that party. The fragility and instability of the fiscal adjustment finished with a distributive conflict within the public sector itself. The total of the state's financial resources and the efficiency of the public economy tended to drop as a consequence of investment rationing. This contributed to a loss of consensus concerning the fiscal adjustment, which led to a decrease in a considerable part of the political weight of the government. More- over, the fiscal problems were combined with difficulties within the state's administrative apparatus. A number of sectors within the governing political force were opposed to the priority given by the executive power to reducing inflation. Neither the provinces nor the state-owned companies were committed to the government's initiatives. In a complex state with very fragmented political and administrative responsibilities, the seeming centralisation of the policy decisions was ephemeral: different sectors were able to extend their budgetary restriction far beyond limits compatible with the anti-inflationary programme. Monetary policy also grew increasingly lax. The rediscounts granted by the Central Bank to the private sector expanded, initially due to problems in the financial entities (which had lost indexed deposits as a consequence of the decline in the inflationary rates), and later to the regional economies and the financing of industrial exports. The 70 Argentina government also faced problems with the official banks in the provinces. These continued to finance the budgetary disequilibria of the local governments, neglecting to meet the standards set by the Central Bank concerning legal reserves. To put the provincial banks in an adequate cash position turned out be a complex political operation, since the actions of the Central Bank could lead to conflicts with provincial governments belonging to other political parties. In some cases the pressures from the provinces were exerted through the weight of their presence in the senate, especially when it came to voting on key issues for the government. In addition to fiscal and monetary policies operating above their prescribed margins, the incomes policy was subject to great pressures. In March 1986 the price freeze was made more flexible to allow for corrections in relative prices. An attempt was made to improve the level of public tariffs and prices, as well as the exchange rate, while at the same time corrective schemes for industrial prices and wages were being defined according to quarterly guidelines established by the government, taking into account expected inflation and not the past one. In mid-1986 a scheme of limited parity negotiations was implemented, through which the government sought to establish a ceiling on nominal wage increases. However, as a consequence of an important strike, the metallurgical trade union managed to bargain for increases higher than those dictated by the government, establishing a point of reference for the negotiations of the other unions. The increases granted to the metallurgical workers were a part, in fact, of a negotiation between the trade union leaders and the government itself. This was a prelude to the later incorporation of a Peronist trade union leader as minister of labour. At the time a part of trade union leadership (especially a group of trade unions wielding considerable power and belonging to the so-called `Group of 15') sought to improve their relationship with the government, while the government attempted to expand its political power by drawing closer to some of the corporate sectors with which it traditionally had been at odds. The combination of these factors became evident in the second half of 1986. Inflation tended to accelerate, and there occurred the first foreign exchange speculative movement since the outset of the plan, as evidenced by an increase in the gap between official and parallel dollars. Throughout the rest of the Radical administration, on several occasions the government had to try to regain control over inflation under increasingly unfavourable conditions. This progressive deterioration was due in part to the response of economic agents to the Mario Damill and Roberto Frenkel 71 successive stabilisation plans. The expectations of a freeze accelerated preventive price mark-ups and tended to neutralise the income policies; lobbying against unfavourable changes in taxation became more intense; and uncertainty led to a strengthening of dollarisation, reducing the favourable effects of the monetisation following the shocks, so that the buffers the stabilisation policy could rely on were increasingly diminished.

Economic Emergency and Structural Reforms

Given the increasing weakness of the anti-inflationary programme, in mid-1986 the Radical government was faced with the dilemma of strengthening the stabilisation policy at the expense of greater political isolation or recovering political space through alliances with different sectors. It believed that if necessary it could offset the negative implications of various concessions on the stabilisation effort. Another possibility, that of forming a reform-oriented political coalition, seemed to be blocked by a hegemonic tendency in government sectors that made the seeking of agreements with the opposition difficult, owing to roadblocks deriving from internal conflicts among the Peronists as well as the double-standard discourse of the so-called `renovated Peronists', the dominant faction in that party. The renovated Peronists combined their new democratic discourse, in similar doses, with criticisms (more consistent in public than in private) against the economic policy of the Radical government, which were labelled as regressive, monetary-slanted, led by the IMF, a continuation of the policies of the military government, and so on. Furthermore the issues of economic reform, centred on restructuring the public sector, trade liberalisation and deregulation, which then appeared to originate from the government in a fragmentary fashion and be imposed by the emergency (and were the result of actions oriented towards solving definite problems rather than forming part of a global strategy) received a clear rebuff from the opposition. They were also actively resisted in the legislative chambers, where, for example, the projects to privatise state-owned companies were harshly resisted, in particular by Peronists, and would not obtain approval during Alfon- sin's administration. In reality both trade liberalisation and the reform of the state were new areas to the two main parties. It is quite clear that this absence of reform-oriented discussion in the main parties and the relative improvisation with which problems were dealt with, facilitated the development of a simplistic version of the liberal-conservative 72 Argentina ideology in these matters. First, the Radical Party and then, much more markedly, the Peronist government of Menem were both permeated by an anti-state privatising vision with scarcely any nuances. They first yielded to this vision for reasons of emergency' (in particular due to the pressure of multilateral financial agencies such as the World Bank) and then in order to appease those who promoted a large reduction of the state in favour of the private sector. Especially from the middle of 1986, the lack of a stabilising political coalition forced the government into sectoral and political accords that involved the partial liquefying of the precarious fiscal-monetary equilibrium attained earlier. The interests of industrial entrepreneurs and pampas landholders managed to obtain representation in the government, as would those of trade unionists in the `Group of 15' with the incorporation of Alderete as minister of labour in March 1987. In any event, the sectoral concessions did not have positive political results for the Radicals, as reflected in subsequent elections. In fact, the year 1987 was critical for the operation of the government, as in September it had to face another risky election in which half of the Chamber of Deputies would be renewed and all the provincial governments. This prospect strongly influenced its actions and decisions. Moreover in the first months of 1987 a dangerous front was reopened when the military issue reappeared in centre stage. First, there was the enactment of the law known as `Punto Final' in relation to trials for human rights violations under the dictatorship. This gave rise to strong reactions even within the government, many of whose members were reluctant to restrict the action of the law in reviewing human rights violations under the military regime. One month later about one hundred officers of the garrison of Campo de Mayo, led by Lieu- tenant Colonel Aldo Rico, mutinied in demand for a `political solution' of the trials of the military involved in the removal of the commander-in-chief of the army, whom they accused of having subordinated the interests of the institution to presidential interests. Alfon- sin was able to overcome this crisis with the help of popular and political support for the legality of the new law, though he was not able to avoid many of the negative consequences of the episode. The September election, which was treated by the government and the opposition as a sort of referendum, substantially changed the political scenario for the rest of Alfonsfn's period of office. Peronism, which had recovered its legitimacy as a democratic alternative, largely due to the actions of the renovated leadership, was able to reassemble itself after the two previous defeats: it obtained 41 per cent of the Mario Damill and Roberto Frenkel 73 ballots against 37 per cent for the Radical Party. This victory not only strengthened its position in Parliament, but also enabled it to control almost all the provincial governments. The plebiscite-like mood that had surrounded the elections created the feeling that the defeat had affected the political legitimacy of the government, and consequently its ability to manage the crisis, even though these negative perceptions were partially and fleetingly offset by a somewhat more cooperative attitude on the part of the Peronist opposition. Those of its leaders who were more convinced of the need to renew the practices of the party (changes that had already borne the fruit of victory or had contributed to it) seemed willing to initiate a new political style with a tone less marked by confrontation and obstruction than in the immediate past. This circumstance made it possible at the end of 1987 and the beginning of 1988 to generate the necessary space for a timid cooperation between the government and the opposition, reflected in the enactment of some proposed bills of law that had been long postponed. Within the context of the above difficulties, the government attempted to strengthen the reforms, especially in the public domain, and rekindle growth. In the second half of 1987 it proposed to Parliament a wide variety of measures, including coparticipation between the central government and the provinces, deregulation of public utilities, the sale of 40 per cent of the state-owned airline, reform of the system of industrial promotion, measures oriented towards deregulation of petroleum activity, reduction of the quantitative restrictions on imports, and trade deregulation in some basic industries (steel, paper, petrochemicals) that had traditionally been protected by high tariffs and trade prohibitions. It was thought that this reform-oriented effort would make it possible to defuse feuds created within the state, and make it possible for the fiscal adjustment to become consolidated and gain in transparency and equity. It was also expected that deregulation would mobilise autonomous private investment by opening up new areas for the private sector that had hitherto been restricted to the public sector. On the other hand, trade liberalisation should contribute to improve the overall efficiency of the economy and reduce the monopolistic quasi-rents. However, these lines of action clashed against the political weakness of the government and the increasing weakness of the administrative ability of the public sector, as no serious attempt had been made to restructure it. In the absence of a reform-oriented project with the backing of its own party, and pressed by the narrow margins of action for stabilisation policies, the Radical government was forced to direct its action 74 Argentina towards a partial and disorderly fiscal adjustment. Occupied by the emergency, the internal and external opposition and the liberal criticism that pointed out `delays' and `hesitations', the government vacillated and, in effect, announced much more than it was actually able to do. Moreover, the incomes policies were faced with increasing limitations. A package of labour laws, promoted by Alderete from the Min- istry of Labour and enacted at the end of 1987, led to the implementation of collective labour bargaining in 1988. The government then lost its capacity to act in a direct manner in nominal wage determination in the private sector. In addition, interest rates were completely deregulated and a free exchange rate was set up for capital transactions, even though a fixed exchange rate was maintained for commercial transactions.

Towards Hyperinflation

The prospects for political cooperation that had surfaced after the 1987 elections rapidly vanished. In the second quarter of 1988, Radicals and Peronists initiated the process of selecting candidates for the presidential elections the following year, so once again the rationale of political competition presided over the relationship between both blocs. The results of the internal elections of the Peronists (whose affili- ates had, for the first time in their history, the opportunity to choose the president) decisively affected the course of events. The victory of Carlos Menem, with 53 per cent of the votes against the 47 per cent obtained by the leader of the renovation movement, Antonio Cafiero, brought two visions and two styles that had coexisted in the party face to face. The first stood for some of the most questionable traditions of Peronism, while Cafiero presented himself as the man who was most identified with republican institutions and the party system. The political scenario and the economic framework described above explain the weakness of the last stabilisation attempt of the Radical government: the Primavera Plan (the Spring Plan). Due to the impossi- bility of adopting an overall scheme of incomes policies as in the Austral Plan, this new plan, launched in August 1988, was based on a dein- dexing agreement with the largest companies. In addition, announcements were made on the future evolution of public prices. The attempt to improve fiscal collections was not based on new taxes (which had to be approved by Parliament, where the opposition could now stop official initiatives with ease), but rather on the new exchange rate mechanism. The latter consisted of a dual market: exports would be converted at a commercial exchange rate set by the Central Bank, while Mario Damill and Roberto Frenkel 75 the financial operations and imports would be cleared in a free market with a floating parity, which the government would attempt to maintain at about 25 per cent over the commercial dollar. The scheme was harshly criticised by the agricultural and livestock sector, which understood it to be the setting up, in a disguised fashion, of taxes on exports. The part of the programme that corresponded to the external sector had been the most precarious one since 1985, given the de facto moratorium on the banks (payments had been defaulted as from April 1988) and the unfavourable development of relationships with both the IMF and the US government. The fragility and inconsistencies of the plan were due to a great extent to the concessions made to pressure groups in exchange for political support. The exchange rate regime, for instance, resulted from discarding the possibility of reestablishing taxes on exports, because the government considered any such reform politically nonviable. Even though the rural sector questioned the program, it restricted its objections to the implicit withholdings in the dual exchange rate market in the hope that the government's promise of a future unification of the exchange rate would be fulfilled. Indus- trial entrepreneurs, in turn, only supported the plan after having obtained reductions in the value added tax. Parliament did not approve or otherwise significantly strip down the laws involving costs to the provinces. There did not exist any coordinating element of the incomes policy at the level of wages because, as already mentioned, this element had been turned over to the trade unions some months earlier. However, the unions maintained or even strengthened their chronic rejection of the government's economic policy despite the fact that, in this case at least, the anti-inflationary policy was ostensibly favourable to their negotiating ability. This exacerbation of the distributive struggle was the setting in which hyperinflation made its appearance. The Primavera Plan was faced with two important constraints. One was due to the shortage of reserves, in conjunction with the lack of external support that the delay in making interest payments had generated. The other was due precisely to the uncertainty created by the proximity of the elections and the stand taken by Menem, which cast great doubts on the future of external negotiations as well as domestic public debt commitments." The IMF refused to give any backing to the last anti-inflationary attempt of Alfonsin's government although the World Bank did commit an important package of credits, which in part mitigated the difficulties in relation to reserves. However, at the end of January, the World Bank informally gave notice that it would not release a significant 76 Argentina part of those loans. The decision was in part a consequence of the inauguration of the new Bush administration, as a result of which the officials who had supported the Primavera Plan left the US Treasury Department. In a climate of marked uncertainty, the negative news on the external front led an important number of agents to begin to dis- pose of their assets in australs and to buy dollars from the Central Bank. Thus on 6 February 1989, in the face of a decline in reserves, the latter decided to withdraw from the free market. The prevailing foreign exchange regime was substituted by another whereby the monetary authority refrained from selling foreign currency not intended for imports, and these began to be channelled through a controlled market, according to a parity fixed at a level higher than the one in force for agricultural exports. When the Central Bank stopped inter- vening, the free dollar increased in an accelerating manner. The evidence that the Bank would have great difficulties in maintaining the parity in the commercial market hastened the increase, giving rise to a speculative bubble. In March there began a massive withdrawal of deposits in dollars from the banking system. Exporters delayed the liquidation of foreign currency, encouraged by the promises of a unified exchange rate mentioned in the addresses of all three presidential candidates, including the representative of the Radicals, Eduardo Angeloz. Several monetary policy actions aimed at holding down the exchange rate increase were fruitless. Important issues of dollarised public debt instruments (National Treasury adjustable drafts), through which it was intended to safeguard the level of reserves by providing the private sector with close substitutes to the dollar, were ineffective in a context of generalised distrust of public debt of any kind. The reserve position of the Central Bank continued to deteriorate, thus providing feedback to the bubble due to its effect on expectations. The increase of the dollar was transferred to prices and was the detonator of the first hyperinflation, which would last throughout the second quarter of 1989. The retail inflation rate, which had been 7 per cent monthly in the last quarter of 1988, was 9.66 per cent in February, 17 per cent in March, 33.4 per cent in April, 78.4 per cent in May and 114.5 per cent in June.'9 The events of the last months of 1988 and the first half of 1989 unfolded in a tense and rarefied political climate, narrowing the margin for action of a government whose days were numbered. In Decem- ber 1988 there was a new military uprising, demanding that Alfonsin adopt decisions politically and morally to legitimate the fight against subversion. The revolt was short-lived, but it revealed another conflict within the military institution. The rebels - elite troops - questioned Mario Damill and Roberto Frenkel 77

the upper levels of command of the army, whom they accused of corruption and lack of military spirit, thus clearly showing the increasing rift in this branch of the armed forces, which had been set up for the Falklands War. A month later an unexpected and swiftly controlled attack on a military garrison by a small left-wing group brought back the memory of not very distant times, which the armed forces shrewdly used to vindicate their past feats and implicitly to condemn the pacifism of Alfonsin. As the day of the presidential election drew closer, the greatest questions hinged not on Menem's possible victory, but rather on the type of combinations that would result if, as was expected, the Peronist candidate did not manage to obtain the votes necessary to gain a majority in the electoral board. All these conjectures vanished on 14 May when the Governor of La Rioja obtained 49 per cent of the ballots against the 37 per cent of Angeloz. With these results, the future Peronist administration would govern in more favourable conditions than those that had been faced by the Radical Party: there was a majority in the Chamber of Deputies, nearly absolute control of the Senate, and 17 out of 22 provincial governments. But there was no time for celebration. At the end of May the increasing social tension, aggravated by the violent effect of hyperinflation on the real incomes of the wage-earning class and on the level of employment, led to the looting of stores in low-income neighbour- hoods. In mid-June, after a fruitless attempt to involve the president- elect in a joint action to cope with the emergency, and with no capacity to control the economy, Alfonsin announced he would resign his position in order to shorten the period of transition, which should have lasted until December. On 8 July, Alfonsin handed over the presidency to Menem. For the first time in 60 years a president-elect was succeeded by another who had also been elected democratically. This remarkable achievement of the reconstruction of Argentinean democracy seemed to lose its importance, however, in the midst of the general atmosphere of crisis engulfing the country.

The `Other' Carlos Menem

Once in office Menem brought about a drastic political shift by replacing the populist preaching he had used in the electoral campaign with what he called the `popular market economy', consisting in the exaltation of orientations condemned by the traditional ideology of Peronism: the end of state interventionism, the privatisation of state- 78 Argentina owned companies, fiscal adjustment, the end of protected capitalism and the liberalisation of the economy. Simultaneously, Menem entrusted the operation of the Ministry of Economy to the members of the board of directors of a great multinational company of Argentinean origin: Bunge and Born. Judged in perspective, Menem's political shift owed much to the conditions created by the current economic condition of hyperinflation in which he had taken office. Those conditions transformed the populist economic policy into something unviable, and offered positive incentives for the reconversion of Menem to the rationale of the emergency. Less surprising than his reversals in economic matters (because he had anticipated them implicitly during his campaign) was the decision adopted by Menem in relation to the judicial problems affecting the military: he granted presidential pardon to those officers on trial for human rights violations who had not been sentenced as yet, and also to those condemned for acts of insubordination during the previous government. This decision was presented as the first part of a policy of national reconciliation that would later include a presidential pardon for the high military commanders who had governed the country from 1976 to 1982. With his new allies, the support of the great trade unions (initially occupying the Ministry of Labour and gaining control over social works), and the acquiescence though not the fervour of his party, Menem as- sembled a powerful coalition around his presidency.

The BB Plan

The change of government in July 1989 was preceded by a favourable change in economic expectations, based on the reassertion of political power made possible by the institutional renewal and on the implementation of a stabilisation plan that could rely on the support of important entrepreneurial sectors. Even in June, when Alfonsin announced his resignation, the bubble in the exchange rate market had been held back spontaneously. Nevertheless, the new authorities had to confront a complex situation characterised by runaway inflation, a lack of foreign currency reserves and accumulated arrears in external payments, an increase in fiscal disequilibrium, the increasing burden of internal debt in an economy with a very low and declining degree of monetisation, an acute recession and unemployment. 20 In the announcement of the new plan, implemented on 9 July 1989, Mario Damill and Roberto Frenkel 79 great emphasis was placed on the proposed structural reforms, which the government intended to implement quickly. The most important element was the privatisation of many state-owned enterprises, which was accompanied by measures of decentralisation and deregulation of economic activity. The set of measures for immediate implementation was similar, however, to the content of the previous stabilisation shock plans. An improvement of the fiscal accounts, one of the central objectives of the programme, would occur basically from the initial recomposition of the tariff level and the reinstatement of export taxes, established during the last month in office of the preceding government. It was decided also to suspend different benefits received by the private sector within the regimes for industrial promotion (already partially suspended by resolutions adopted by the previous government) as a consequence of the elimination of tariffs. The measures for short-term fiscal adjustment requiring approval from Parliament were grouped in a single law called `Economic Emergency'. Those oriented at regulating the transfer of public assets to the private sector became the State Reform Law. Both were approved by Congress within the first sixty days of the new administration. A new tax reform law would, however, only be approved in December. Besides the initial adjustment of tariffs, a unified exchange rate at 650 australs per dollar was considered. This involved a correction of the commercial exchange rate in the order of 170 per cent. The government also attempted to influence the course of nominal private wages, which would continue to be negotiated by collective bargaining, by means of indicative guidelines. With respect to prices, freezing was discarded by decree. Instead, the economic authority negotiated an agreement with representatives of leading companies to commit themselves to adopting the exchange rate and public tariffs as `anchors'. It was also announced that in the very near future negotiations would be started with the IMF and the creditor banking system. On the external front the situation was contradictory, with a high and increasing trade balance and accumulating interest arrears since April 1988, for which the negotiations had been interrupted. The price agreement was effective and, combined with the freezing of the exchange rate and public tariffs, it led to a progressive fall in the inflation rate from a peak in July of 200 per cent to 5.6 per cent in October. Residual inflation was a consequence of the behaviour of goods with flexible prices, especially private services, which increased far more than other prices. 80 Argentina

Concurrently, the fiscal situation improved notably. In the last four months of 1989, even though the expenditures of the Treasury increased, there were increasing operational surpluses of the order of $100 million a month. These results were the best attained since the Austral Plan. The degree of monetisation of the economy also increased rapidly. In the meantime the progressive lag in the exchange rate in a context of greater liquidity created conditions favouring the emergence of a positive gap between the parallel dollar and the unified dollar. Thus, despite the fact that the macroeconomic indicators showed a relatively favourable evolution (which added to the good prospects in the external negotiations and led to the signing of a standby agreement with the IMF in November), there were problems in the exchange market. The gap between the official dollar and the parallel dollar expanded and was more than 10 per cent in the last week of October. The increase in the parallel dollar accelerated during the first half of No- vember. The instability of monetary policy was combined with political complications for the government, giving rise to significant changes in private portfolios. During that period there were some trade union conflicts of importance and great public impact, in the face of which the authorities did not adopt the strong policy demanded by the conservative sectors allied to the government. Concurrently, in their own negotiations the unions were obtaining important increases. The rift in the Confederacion General del Trabajo (General Federation of Labour or CGT), which had occurred only a few months before (giving rise to the `Menemist' CGT and to another headed by the leader of the beer brewery workers, Saul Ubaldini), and inter-trade union competition contributed to making the struggle over salaries more acute. On the other hand, the disagreements between the economic authorities and the entrepreneurial sectors in connection with the characteristics of the tax reform gave rise to doubts among the entrepreneurial coalition as to the soundness of the programme. In the context of strong volatility of expectations, enhanced by the recent experience of hyperinflation, the lack of definition of policies seems to have been especially detrimental. The successive attempts of the Central Bank to control the increase in the exchange gap ended in failure. In mid-November the exchange gap amounted to 50 per cent. When it became evident that a readjustment of the programme was under study, the foreign exchange market changed quickly. The `gap' tended to reduce, indicating that a correction of the exchange rate was expected, and that probably the gap would be stabilised at a lower Mario Damill and Roberto Frenkel 81 level, according to the sequence known in the previous temporarily successful stabilisation packages. On 10 December Minister Rapanelli announced a new plan. This did not consist, however, of marginal readjustments in relation to the current scheme. The foreign exchange market was broken up into an official one, whereby the parity would be 1000 australs to one dollar, thereby validating the levels previously reached by the foreign currency in the parallel market, as well as the free market. The devaluation of the commercial exchange rate was 53 per cent. Tariffs were also increased by between 60 and 70 per cent and a lump-sum salary increase was given. To this was added a financial measure that undoubtedly had a great impact on the future course of the economy. It was decided to reschedule the maturities of capital of the internal debt of the Treasury at two years. This measure is difficult to explain if it is considered that it only affected approximately 25 per cent of the internal debt, at a cost that was most certainly very high in terms of credibility. Several announcements in relation to fiscal and monetary austerity, which were a part of the shock of 10 December, were totally ineffectual in contending with the devaluation, the increase in tariffs above inflation expectations and the rescheduling of the debt. When the banks opened the day after the plan was announced, the exchange rate gap jumped to 40 per cent over the new official dollar and real interest rates rose to the order of 50 per cent a month. The measures of 10 December, which reminded people of the `Rodrigazo' in mid- 1975, a landmark in the inflationary history of the country, were the detonating element of the second hyperinflation, which lasted until March 1990. One week after this attempted readjustment a new minister, with no connection to the entrepreneurial group that had supported the previous plan, announced a new set of measures that drastically changed the former guidelines.

The `Exchange Rate Revolution' and the Second Hyperinflation

On 18 December 1989, Erman Gonzalez announced the elimination of controls on exchange rates, a floating rate and the suppression of all price controls. From that moment, in spite of the ups and downs of the succeeding economic situations, Menem was to emphasise the orientation towards economic deregulation, trade liberalisation and reform of the public sector, especially fiscal adjustment at any price' and privatisation of state-owned enterprises. The guidelines were similar 82 Argentina to the so-called `Washington Consensus'. They were also combined with an alignment of external policy with the major Western powers, especially the United States. This attitude generated decisions such as the participation of Argentinean forces in the Gulf War and a break with the movement of non-aligned countries. Until mid-1991, the government abandoned its attempt to establish a consistent set of incomes policies that would complement its actions in fiscal and monetary matters, relying on the latter only in its fight against inflation. The initial fate of this new set of measures was not any better than the preceding one. After a very brief pause the exchange rate began to increase strongly again and interest rates shot up, exerting pressure on the growth of internal public debt. Moreover, it leaked out that the government was studying a dollarisation programme, which would consist in fixing the exchange rate with free convertibility. These rumours intensified the rate of depreciation of the austral, and the situation became unmanageable. In order to avoid a generalised bank run, the government opted for a drastic solution that, apart from substantially reducing the stock of monetary resources in the hands of the public, also made it possible to eliminate the burden of short-term interest payments on the internal

public debt. The so-called Bonex Plan, implemented on 1 January 1990, stipulated that fixed-term deposits in the financial system would be replaced by public debt certificates with a maturity of ten years; that is, in BONEX bonds at par and converted at an exchange rate of 1830 australs per dollar, near the parallel dollar at the end of December. These measures involved an important capital loss for holders of fixed- term deposits, given their at par conversion to BONEX, as the value of these certificates in the secondary market was to be much lower than their face value. Towards the end of January public tariffs, which were not modified in the Bonex Plan, showed a considerable lag. The government decided to apply a new tariff shock. The increases averaged 97 per cent. This adjustment operated as a coordinating element for inflationary expectations and led to a new acceleration. Inflation, which was 6.5 per cent in November 1989 and 40 per cent in December, averaged approximately 80 per cent a month in the first quarter of 1990, the period of the second hyperinflation. The government responded with a strong monetary restriction, requiring banks, which were losing deposits, to repay rediscounts granted over the previous months and set low limits of indebtedness with the Central Bank for financial agencies. This resulted in a significant and Mario Damill and Roberto Frenkel 83

unusual event: in order to keep their accounts within the limits of the regulations established by the monetary authority, banks sold off foreign currency (or forced their clients to pay off their loans, which they also did by reducing their net positions in foreign currency), and at the beginning of March there was an excess supply in the foreign exchange market. While previously the monetary policy had been ineffective in influencing the exchange rate, in this case, by operating on banks practically on the verge of bankruptcy and forced by the institutional regulations to `demand money', the action of the Central Bank curbed the exchange rate bubble. What seems to have influenced the banks' actions was the perception of the government's firm decision not to soften exchange rate policy, even in the face of a risk of important bankruptcies in the financial system. It is undeniable that the elimination of the exchange rate bubble and the curbing of hyperinflation with no other instrument than monetary policy and announcements of a fiscal nature was a great victory for the government, despite the fact that residual inflation stood at two digits (11 per cent a month between March and December 1990). At the beginning of March the government announced a new set of fiscal emergency measures: payments to public works contractors and the acknowledgement of higher costs were suspended for sixty days and all contracts and bidding processes were called off, as well as drawback payments on exports; the suspension of the reduction in tariffs and other benefits to promote industrialisation were likewise further deferred, and several provisions relating to administrative restructuring were announced. These actions received a wide array of support from entrepreneurs and political figures of a liberal-conservative background.

The Post-Hyperinflationary Consensus

After having overcome the second bout of hyperinflation and despite the persistence of two-digit inflation rates, there began a period of relatively undisturbed calm, allowing Menem quickly to recover his popularity and political space. The repetition of the inflationary experience brought about a certain consensus in favour of the autonomy of the executive. This consensus expressed itself in a change in the priorities of society, placing the control of inflation at a level it had never been before. A similar effect was to confer an uncommon value onto privatisations and the reduction of state spending. In this way, policies and methods that would have been questioned before (for 84 Argentina instance, the closure of banks and state-owned companies and the suppression of public services) came to be positively valued, in the hope that they would open up new roads to overcome a very prolonged period of crisis and stagnation. The fear that chaos could be repeated led society to adopt a sort of veneration towards pragmatism. Menem showed great intuition in perceiving these changes in the minds and perceptions of society. His image and ability to act widely benefited from the emergence of this consensus following the hyperinflation process. The effect of the overpowering response to the military insurrection of 3 December 1990 is also worth mentioning as a factor favourable to Menem and his government's image. The repression of the rebels consolidated the president's image of authority and political competence. The corruption scandals that threatened the legitimacy of the government were momentarily eclipsed by the repercussions of the military crisis. These political victories were added to a series of accomplish- ments on the road to an overwhelming concentration of power in the hands of the president: extension by decree of the time limit for his extraordinary powers; little or no participation of the Congress in rati- fying transcendental measures; and an increase in the number of members of the Supreme Court, giving rise to a court sympathetic to the president. The privatisation of ENTEL (Telecommunications Enterprise) and Aerolineas Argentinas also strengthened the government.

The Period of Rapid Exchange Rate Appreciation

The end of the exchange rate bubble in the first quarter of 1990 was reflected in a fall in inflation rates over the following months. After the monetary-fiscal shock of February-March, inflation rates fluctuated between 10 and 15 per cent a month, with an important inertial component resulting from the rearrangement of mechanisms specific to the high inflation regime. Within this context, the demand for money recovered significantly from the depressed levels recorded in Febru- ary. This increase enabled the Central Bank to buy foreign currency without generating upward pressures on the exchange rate. In fact, reserves increased rapidly and the real exchange rate progressively fell to levels below any recorded in the 1980s. After some unsuccessful attempts to move the exchange rate upwards to avoid a greater appreciation, the Central Bank opted for an attitude of greater passivity - motivated by fear of expanding the monetary base - and waited for a convergence of the inflation rate and the evolution of the exchange rate. However, the convergence did not take place, giving rise to the Mario Damill and Roberto Frenkel 85

above-mentioned appreciation of the austral .21 This persistent appreciation added to the progressive deterioration of the fiscal accounts, which despite the improvement they had displayed after the second hyperinflation, showed very unfavourable movement towards the end of the year. Both factors nurtured a new exchange rate bubble at the beginning of 1991. In January the free dollar went up by about 70 per cent in nominal terms. The exchange-rate run led to the resignation of Gonzalez, the minister of economy. His successor, Domingo Cavallo, announced at the time a set of measures aimed mainly at an improvement of the public accounts. At the same time an important decrease in import tariffs, aimed at increasing the liberalisation of the economy, was announced. The first achievement of the new measures, and of the new minister's firm determination to intervene in order to regulate exchange rate parity, keeping it within a `band' established at the time by the Central Bank, was to curb the exchange rate bubble that threatened to detonate a third episode of hyperinflation. The economic scenario at the beginning of 1991 was especially dramatic and quite clearly demonstrated the accumulated effects of the successive stabilisation efforts, undertaken in conditions of increasingly heightened precariousness, and of the two episodes of hyperinflation. The macroeconomic performance indicators speak for themselves. GDP fell in 1990 to a level similar to that of 1982, the lowest of the past decade. Gross investment continued to contract until it fell to magni- tudes of between 7 and 8 per cent of GDP, below all previous records and at a level indicating that net investment was negative. The rates of open urban unemployment reached their historical maximum levels in the first quarter of the year, coming close to 9 per cent of the economically active population (EAP). The degree of monetisation and internal financial intermediation also fell to all-time lows, especially during the crises of hyperinflation, and even though these tended to recover they did not return to their previous levels. Oscillations of relative prices, likewise, have been of an uncommon magnitude throughout more recent years. Real industrial salaries in 1990 were only 7 per cent above the 1982 average, the lowest of the 1980s, and they were 30 per cent lower than the peak reached at the beginning of Alfonsin's government in 1984. The poor performance of these indicators contrasts with the achievement in 1990 of a record balance of trade surplus of over $8 billion, making it possible to attain a positive current account balance for the first time since 1978. This was in part due to the acute recession (with the consequent contraction of imports of inputs) but also to increased 86 Argentina sales abroad. The value of exports grew at a yearly average rate of nearly 25 per cent between 1987 and 1990. The trade surplus, in the absence of an equivalent primary fiscal surplus, was one of the reasons for the sharp drop in the real exchange rate.

The Convertibility Plan

The exchange rate crisis at the beginning of 1991 made Menem's government significantly alter its course. The choice was made to abandon the floating parity scheme, which was particularly inadequate in an economy that showed such marked features of instability. However, there was no going back to a policy of a fixed rate established by the Central Bank. The hub of the new stabilisation plan was to establish the free convertibility of the austral at an exchange rate prescribed by law and guaranteed by the Central Bank by the maintenance of sufficient foreign currency to support the monetary base. This was combined with a deindexation of the economy, also established by law. Provisions of indexation were forbidden in contracts of all types. The new minister emphasised the line of continuity with the preceding economic policy in the area of structural reforms, especially privatisation and liberalisation, and in relation to the `retreat of the state' from the market and the suppression of regulations. He also reaffirmed the freedom of firms to set their own prices. However, his attitude on the latter would come to be quite different to that of the preceding period. An extensive set of incomes policies was concealed behind the non-interventionist discourse. In addition to the important roles given to the exchange rate and public tariffs in the anti-inflationary strategy, a number of other actions were aimed at exerting an influence on the evolution of private wages and prices.

In summary, the new stabilisation plan, in force as of 1 April 1991, had the following main components:

A set of actions aimed at improving the fiscal accounts. Several taxation measures were included as well as new public tariff adjustments. The government also stated its intention to develop an intensive tax compliance enforcement action to reduce the high levels of tax evasion. The establishment of the convertibility of the austral through a law enacted by Congress, compelling the Central Bank to maintain reserves in gold, foreign currency or certificates in foreign currency for an amount equivalent to 100 per cent of the monetary base (at Mario Damill and Roberto Frenkel 87

the minimum) at the parity stipulated by law. The liberalisation of the economy, expressed in an important customs tariff reform that eliminated specific import duties and the previously existing quantitative barriers. This reform established three tariff levels, resulting in an average tariff slightly lower than 10 per cent, half of the previously existing level. A prohibition on indexation clauses in contracts of any kind.

Through these measures the plan attempted to obtain a rapid and substantial drop in inflation rates.22 It was expected that the increase in the purchasing power of wages, the return of commercial credit and the decline in interest rates that should result from this policy would bring about an important recovery of production. This should contribute, in turn, to an increase in tax revenues. The greater tax revenues would facilitate a substantial improvement in the fiscal balance, which was absolutely indispensable, as under the plan the public sector was not able to receive monetary financing from the Central Bank. The new policy had a positive impact on expectations, and the impact-effect of the plan was the one expected, though with a single and important exception: except for some isolated cases, there was no reduction in nominal prices. The rates of interest fell abruptly. Inflation decelerated in an important manner and the fiscal situation improved noticeably. In the last two months of 1991, for instance, inflation measured by the consumer price index was 0.5 per cent a month, whereas the wholesale index showed a slightly negative movement. It is necessary to go back to 1974 to find comparable inflationary numbers. The recovery of the purchasing power of the sectors receiving fixed incomes, due to lower inflation and the fall in interest rates, prompted a reactivation of production. These elements, combined with developments in external financial relationships, which were consolidated in mid-1991 in a stand-by agreement with the IMF (and further strengthened in 1992 by joining the Brady Plan), reinforced the plan shortly after its launch and enabled the government to obtain an important electoral victory in the elections at the end of the year. Similarly, measures of structural reform were carried out, such as those with respect to privatisation, the sale of public assets, trade reform and deregulation of economic activities, in all of which the government managed to develop a public image of relative efficiency, despite a great number of difficulties. The privatisation process was especially criticised for its lack of transparency and because of several complaints of corruption and mismanagement. 88 Argentina

The greater soundness of the exchange rate anchor was one of the factors supporting the anti-inflationary results of the convertibility plan. The rapid and intense trade liberalisation and sectoral agreements on negotiated prices also contributed to the control of prices. It should also be pointed out that it seems that wage deindexation was greater than in previous stabilisation attempts. This is associated with an evident loss of political power of the trade unions. With regard to inflation and relative prices, the most serious concern was (and continues to be) the very low (and declining) level of the real exchange rate. At the end of 1991 the real parity for exports was 30 per cent below that which the government itself had taken as a `reference' (and therefore as a goal) at the outset of the programme. The exchange rate appreciation and productive reactivation generated by the plan intensified the decline of the trade balance, which already showed a deficit of some importance in 1992. Temporarily, however, the foreign currency generated by privatisation and the sale of public assets financed the disequilibrium, in much the same way as the large increases in inflows of private capital were motivated by the fall in the international interest rates and the greater predictability of the course of domestic inflation and the exchange rate. Apart from the persistent problem of exchange rate parity, the fiscal area was the most prob- lematic. Despite the difficulties in fulfilling the goals agreed upon with the IMF, it is unquestionable that, on the one hand, the fiscal revenues had been increasing in an important manner and that, on the other hand, the income generated by privatisations, the sale of public assets and public bidding for petroleum exploitation areas had been higher than had been anticipated. The latter enabled the government to maintain in full force the stand-by negotiated in 1991 and opened the door for the Extended Fund Facilities loan obtained in 1992. At the beginning of 1992 the government proposed several important reforms, including a tax reform. A social security reform based on the development of private retirement pensions was also under consideration, as well as a reform in the system of healthcare insurance. The results of these reforms (which require the approval of Parliament and are consequently subject to modification), are a matter of speculation among specialists. The success of the tax reforms is likely to depend on their degree of success in reducing tax evasion. At the monetary level there were major difficulties in the first year of convertibility. The fiscal results made it possible to maintain the required ratio between the monetary base and the reserves in foreign currency, and in a climate of increasing confidence and optimism the Mario Damill and Roberto Frenkel 89 remonetisation process continued. The expansion of dollar deposits in the domestic financial system was also important. In mid-1992 they amounted to more than $9 billion. Due to their importance, the privatisation process and the agreements reached with the creditor banking system within the framework of the Brady Plan deserve separate treatment. The next two subsections are devoted to these topics.

Privatisation with foreign debt-equity swaps Menem's government undertook a process of privatisation that, due to its scope, is without doubt among the boldest ever attempted. The privatisation of ENTEL and Aerolineas Argentinas were completed in November 1990 and became a landmark in the implementation of that policy. In fact, the reduction in external debt resulting from these two operations (more than $7 billion) place them among the most important ever carried out at an international level. In the view of the government, the success of any privatisation involves benefits of different types. In the first place, an increase in the overall efficiency of the economy can be expected. Second, the transfer of economic activities with a deficit from the public sector to the private sector allows for an improvement in public finances. Third, the transfer of activities from the sphere of a financially smothered public sector to a private sector with surpluses will facilitate the at- tainment of investment plans. Fourth, the government understands that the success of privatisation is a key signal for the recovery of the confidence of private investors and the support of the international financial community. Finally, in Argentina the implementation of a number of privatisations through foreign debt-equity swaps made it possible to make headway in the eventually successful endeavour to gain access to the Brady Plan. In this sense, it is not surprising that the government should have totally liberalised the regulations on foreign investment, granting it national treatment, eliminating the requirement of prior authorisation and doing away with the preexisting restrictions on remitting profits abroad. In the first stage, the government decided that the privatisation of ENTEL, Aerolineas Argentinas and a group of industrial companies controlled by the Ministry of Defence would be effected through foreign debt-equity swaps. In the second stage, launched in October 1990, national and international public auctions were used to either sell or grant the concession to the private sector of Empresa Lineas Maritimas 90 Argentina

Argentinas (a state-owned merchant shipping company), Administracion General de Puertos (a port management company), Empresa Nacional de Correos y Telegrafos (a postal and telegraphic company), Yacimientos Carboniferos Fiscales (collieries), Obras Sanitarias de la Nacion (sew- age utilities), Subterraneos de Buenos Aires (the Buenos Aires under- ground railroad system), Casa de la Moneda (the mint), Servicios Electricos del Gran Buenos Aires (an electricity company), Gas del Estado (a gas company), and the field units and grain elevator termi- nals of the Junta Nacional de Granos (National Grain Board). The debt- equity swap mechanism was also used for privatisations carried out by provincial governments and in a programme to bail out a portfolio of domestic loans of the Banco Nacional de Desarrollo (BANADE), the official agency specialising in investment loans to the industrial sector. Among the privatisations requiring a prior regulatory framework were Gas del Estado, Obras Sanitarias de la Nacion (OSN) and Servicios Electricos del Gran Buenos (SEGBA). At the end of 1991 Congress approved the regulatory framework for the electricity sector, including authorisation to privatise the generation and transmission facilities of SEGBA, Agua y Energia Electrica (AyEE) and Hidronor. In addition, about 30 companies in the area of defence were to be put into private hands.

Extended fund facilities and Brady Plan After the enforcement of the Convertibility Plan several important events took place with regard to Argentinean external financial relations. The first was the regularisation of relations with official creditors. The second was the return of the public sector to the private international market for voluntary loans, a token of which was the placing of short-term public securities in the last months of 1991. At the beginning of 1992 an extended fund facilities loan was granted by the IMF, and shortly afterwards an agreement was reached with the creditor commercial banking system within the framework of the Brady Plan. Of the total commercial bank debt of US$31 billion (December 1991), US$23 billion was principal and US$8 billion was defaulted interest payments. The Brady agreement involves differential treatment between defaulted interest payments and the principal. The latter is refinanced totally while the former is not. In all the cases of countries participat- ing in the Brady initiative, the norm was that they should pay about 15 per cent of defaulted payments as an act of good faith in the negotiation, and the refinancing of these was less favourable than the prin- Mario Damill and Roberto Frenkel 91 cipal. In the case of Argentina these norms were abided by: the principal was refinanced at 30 years (with a discount depending on banks opting for `au par bonds' or `discount bonds', the latter with a discount of 35 per cent), a part of the defaulted payments of interests was paid (US$1.21 billion) and the remainder of the US$8 billion of defaulted interest payments was refinanced at 12 years with no discount. In addition the monthly interest payment was increased from US$60 to US$70 million until the `small letters' of the agreement had been signed, and a further payment of US$300 million was made in bonds. Considering the short- and mid-term prospects of the economy, as important as the Brady Plan are the goals agreed upon in the Extended Fund Facilities obtained from the IMF, because if the goals considered in the latter are not attained the Brady Plan will not survive either. The basic idea underlying this programme is that the country will generate a public sector primary surplus between 1991 and 1995, such that it will be enough to amortise the interest due and the total debt in full, not only that considered under the Brady Plan, but also the one corresponding to agencies, Bonex and so on. To reach these goals, in the period 1992-4 it would be necessary to maintain an average primary surplus of US$3.3 billion. This is quite close to what was agreed upon in the standby signed in 1991, whose goals were met by utilising the proceeds of privatisation. Therefore, it will not be that simple to attain this objective after 1993, when the revenues from privatisation will be significantly reduced. Nevertheless, there are favourable signs, especially when looking at the achievements of the government in the field of tax collection. In the first nine months of 1992, for instance, due to the strong increase in revenues generated by the value added tax, for the first time the amortisation goal was achieved without having to resort to privatisation revenue. The second important issue is that it is necessary to obtain foreign currency in order to make interest payments. If the trade surplus no longer exists and the bulk of financing from the multilateral agencies has already been obtained, the only source of foreign currency is an inflow of private capital. It is for this reason that, within the programme agreed with the IMF, it is estimated that the net inflow of private capital between 1992 and 1995 will have to be in the range of US$3.1 to US$3.9 billion a year. That is, the success of the Brady Plan depends crucially on capital flows. If these are not sufficient, the only possible way of obtaining the necessary foreign currency will be to bring about a sharp recession, which, by reducing imports, will free 92 Argentina the foreign currency required to pay external interest. If this does not occur, the country will be in no position to comply with the Brady Plan even though the government may meet the remaining guidelines. Obviously, if the opposite were to occur - that is, if enough foreign currency were generated but not a corresponding fiscal surplus - the goals would not be met on the latter ground. In fact, if the government does meet the fiscal goals and the expected inflow of private capital does materialise, stability is very likely. However it is worth raising the question of whether stability will be sufficient in itself to guarantee growth. It seems that, even if everything works well, the resulting investment rates may not be enough to sustain rapid growth. This would result in a `low level equilibrium'; that is, relative stability but with slow growth. In this scenario, the difficulties of preserving stability would probably increase, especially to the extent that attenuation of the risk of high inflation would tend to reduce the relative 'post-hyperinflation process consensus', rekin- dling distributive demands and pressures.

3.4 FINAL CONSIDERATIONS

A crucial aspect of the difficulty of managing economic policy at the outset of democratic transition in Argentina has been that related to the prevailing diagnosis of the situation in 1983. It was noted that the two major parties, the Peronist Party and the Radical Party, shared the view that the worst part of the crisis already belonged to the past. This proved dramatically incorrect. The process of learning the real nature of the restrictions facing the country developed more or less in tandem with the successive stabilisation attempts, but with some lag. It seems that it was within the executive power, and especially among the small group who formulated economic policy, that an awareness first developed of the priority that stabilisation should have over other objectives, and of the dimension of the fiscal adjustment that would be needed. The Radical Party was very slow to acknowledge the restrictions and priorities. A more or less thorough understanding was only arrived at as a consequence of the hyperinflation of 1989 and the resulting electoral defeat of the party. The Peronist Party, on the other hand, found neither the time nor the opportunity to think the issue over, since it devoted all its energies to regaining political influence and power. A true understanding of Mario Damill and Roberto Frenkel 93

the dimensions of the crisis arrived at only in 1990, after the second episode of hyperinflation marked the end of the initial stabilisation attempt of Menem's government. We would like to highlight the possibility that these poorly adjusted perceptions of the situation might have contributed to the obstruction of a cooperative approach; that is, the development of concerted forms of action in defining policies. Political and social `concertacion' (coalition) was waved as a flag of democracy from the very inception of the transition. However, after Alfonsin took office there was a revival of zealous competition between the two major parties, firmly rooted in the past, but now far more intense due to the fact that the Radical Party had proven itself able to challenge the traditional electoral hegemony of the Peronists. Thus, adversarial politics became the rule and cooperation the exception. After the loss of the achievements of the Austral Plan (and subsequently as an outcome of the first hyperinflation) the Radical Party and Alfonsin became worn out, and the result of the interparty competition was a redistribution of political power in favour of Peronism. If a more or less shared and deficient understanding of the situation contributed to the restoration of strong political competition, it is no less true that the majority parties in Argentina did not stand alone in this respect. It is true that their doctrines focused fundamentally on development and distribution, leaving little room for fiscal equilibrium and new topics relating to structural reform, now understood as key factors in the retreat of the state from the economy. It is also true that the ability of the democratic parties to exercise power and manage the economy had been weakened by the protracted period of military rule. However, it is the novel character of the problems encountered that explains the difficulties they had in understanding the overall situation. It is worth remembering that similar difficulties were experienced by multilateral financial institutions such as the IMF and the World Bank, which until the end of the 1980s adhered to the diagnosis of a `transitory crisis of liquidity'. The main novelty of the situation was the magnitude of the disequilibria. In the first years of the 1980s, the Latin American economies, and the Argentinean one in particular, suffered what can be considered as a 'non-local shock', or rather a series of shocks. These shocks generated disequilibria of the order of 10 per cent or more of GDP in the fiscal accounts and of a comparable dimension in the external accounts. In addition, the inflationary processes underwent remarkable transformations, giving rise to new institutions and practices associated with 94 Argentina

prices rising substantially higher than those prior to the shock. In this situation, neither the creditor private banks nor the multilateral institutions contributed in any important way to improving the faulty analysis and generating adequate policy recommendations. Ini- tially the banks and the IMF exerted pressure in the sense of ensuring that priority was placed on external adjustment and the generation of sufficient commercial surpluses to balance the current account at any cost; that is, they underrated the destabilising effects of external adjustments on other macroeconomic variables, such as fiscal accounts and inflation rates. The traditional IMF stabilisation policies were clearly inadequate within the new context. These programmes were conceived to cope with temporary and relatively minor disequilibria in the external and fiscal accounts and with moderate inflation rates. In such situations the combination of devaluation and austerity operated more or less reasonably to reestablish basic macroeconomic equilibria, if at the expense of generating a recession and unemployment. But even this second-best solution could not be attained in the new situation, given the magnitude of the disequilibria and the existence of high inflation. The 'trickle-down' effects of the IMF-type programmes contributed to moving the economy on to an explosive path, and in the end the government had to discontinue its policies. Another important aspect of the management of economic policy within the new democratic context is related to the tendency of the economy to drift along explosive paths. The urgencies derived from this situation progressively necessitated a particular style of intervention: in emergency situations of this kind it becomes necessary that an agent should expediently and efficiently coordinate collective action. Thus the indispensable need for governance capacity to act in the face of challenges posed by an economic emergency found an answer: strong and unilateral initiative of the executive power. Successive shock stabilisation programmes were implemented in a similar manner. The intervention of the executive power in these exceptional situations followed a set pattern. A set of decisions was prepared by technicians operating in relative isolation from social and political pressures. These decisions determined the form of packages of measures, which at times required parliamentary approval. Thus administrative discretionary action displaced political negotiation, limiting any possibility of political and social agreements in situations of hyperinflation. Within the context of hyperinflation, the state itself suffers a harsh blow as it is the guardian of economic transactions and social coexistence. As J. C. Torre Mario Damill and Roberto Frenkel 95 states,23 within such a framework it is understood that the way out of hyperinflation is to restore the central autonomy of the state. That is, there is a need for intervention based on the application of emergency power (such as emergency decrees, provisional measures and so on) in an effort to free decisions and conflicts from political nuances by in- voking economic rationality. Ironically, this occurs in a mandate whereby the executive power invests itself and thrives on the demand for governance, which generates the crisis itself. In seeking governance capacity the results arrived at are quite removed from the procedures of political discussion and participation that are associated with cooperative strategies. This description is very akin to that observed in Argentina, especially after the second hyperinflationary episode, when Menem's style of government emphasised its `decisional' features, favoured by a strong concentration of power around the president. However, this evolution towards a less participatory democracy and towards a climate of pragmatism, with a marked inclination towards results over and above the methods whereby they are attained, has its own risks and limits. The most dangerous risk is that the political situation may become very dependent on an economic success that is likely to remain fragile for a considerable time. Mistakes in economic implementation can be very harmful to the image of the executive and of the president himself, as evidenced by the rapid reduction in Menem's prestige at the beginning of 1990.24 Thus, it is possible to argue that the consolidation of the democratic regime under Menem's government was based in part on the positive but short-run effects of measures that had some detrimental features in the mid-term on the vitality of the democratic institutions. Of particular note was the tendency of the government to be autocratic and discretionary when making decisions. 96 Argentina

APPENDIX 3.1

Table 3.1 Inflation, growth and balance of current transactions with the rest of the world, 1960-91

Balance of Payments Rate of growth (millions of dollars) of GDP Inflation rat e ' (%) (%) Trade balance Current account

1960 7.9 12.1 -170 -197 1961 7.1 18.8 -496 -572 1962 -1.6 31.8 -140 -268 1963 -2.4 27.6 385 234 1964 10.3 18.1 333 36 1965 9.2 38.2 295 195 1966 0.6 29.9 468 216 1967 2.6 27.3 369 135 1968 4.4 9.5 199 -45 1969 8.5 6.6 16 -222 1970 5.4 21.7 79 -156 1971 4.8 39.1 -128 -389 1972 3.1 64.1 36 -223 1973 6.1 43.7 1.037 711 1974 5.7 40.0 296 128 1975 -0.5 335.1 -985 -1.289 1976 -0.5 349.0 833 650 1977 6.3 160.0 1,490 1.290 1978 -3.3 169.0 2.566 1.834 1979 6.5 140.1 1.110 -550 1980 1.0 87.5 -2.519 -4.770 1981 -7.0 131.2 -286 -4.714 1982 -5.8 209.7 2,288 -2.358 1983 2.6 433.6 3.331 -2.461 1984 2.2 686.8 3.523 -2.391 1985 -4.6 385.4 4.582 -953 1986 5.8 81.9 2.128 -2.859 1987 1.8 174.8 540 -4.238 1988 -3.0 387.7 3.810 -1.572 1989 -4.4 4923.3 5.374 -1.292 1990 0.4 1343.9 8.261 1.7502 1991 4.52 84.0 4.200' n. a.

Notes: 1. Between December of each year and the same month the previous year, measured by the consumer price index (CPI). 2. Estimated. 3. Estimated on the basis of data for the first ten months of the year.

Sources: INDEC, (1993); CEPAL (1986, 1988). Mario Damill and Roberto Frenkel 97

Table 3.2 National income, savings and investment (% of GDP)

Period GDP National Consumption National External Total Exports Imports Share income savings savings savings of public investment in total investment

1961-65 100 99.4 80.1 19.3 0.5 19.8 10.9 10.7 34.8 1966-70 100 98.3 78.6 19.7 -0.2 19.5 11.3 9.2 36.4 1971-75 100 100.0 79.5 20.5 0.6 21.1 8.2 8.9 40.0 1976-80 100 97.7 75.9 21.7 0.6 22.3 11.8 11.2 52.8 1981-83 100 92.6 80.9 11.7 5.1 16.8 13.9 12.8 55.5 1984-86 100 91.4 82.4 8.9 3.0 11.9 15.3 9.9 62.6 1987-88 100 90.2 81.9 8.4 4.5 12.9 15.4 10.2 n. a. 1989 100 88.7 80.2 n.a. n.a. 8.8 19.5 8.3 n. a. 1990* 100 n.a. 77.4 n.a. n.a. 7.3 23.3 8.2 n. a.

* Provisional data. Source: Banco Central de la Reptiblica Argentina (1985, 1992).

Table 3.3 External savings, fiscal deficit and private surplus (% of GDP)

External Fiscal Private & savings deficit financial surplus

1961-65 0.5 5.9 5.4 1966-70 -0.2 2.5 2.7 1971-75 0.6 8.2 7.6 1976-80 0.6 7.4 6.8 1981-83 5.1 14.6 9.5 1984-86 3.0 7.8 4.8 1987-88 4.5 6.8 2.3 1989* 4.6 7.5 2.9

*Estimated.

Source: Banco Central de la Reptiblica Argentina (1981, 1991). 98 Argentina

Table 3.4 Real exchange rate and real wages (1980-100)

Real Wages* Real exchange rate for exports

1971-5 115.4 149.2 1976-9 82.4 137.6 1980 100.0 100.0 1981 90.8 136.1 1982 80.8 165.8 1983 106.5 155.3 1984 129.5 148.4 1985 104.1 167.6 1986 106.3 186.0 1987 99.9 213.0 1988 95.0 192.4 1989 86.2 212.6 1990 86.2 154.3 1991 85.6 116.3

* Average salary in the manufacturing industry.

Source: FIEL, `Indicatores de Coyuntura', nos 266 (May 1988), 237 (De- cember 1985), 315 (June 1992).

Table 3.5 Total external and public debt

Total Total public debt (million US$) (%)

1976 8.279 62.7 1977 9.678 62.5 1978 12.496 66.8 1979 19.034 52.3 1980 27.162 53.2 1981 35.671 56.1 1982 43.634 65.5 1983 45.069 70.4 1984 46.903 77.1 1985 49.326 80.8 1986 51.422 85.6 1987 58.300 88.9 1988 58.500 91.5 1989 63.300 92.3 1990 61.270 n.a.

Source: CEPAL (1992). Mario Damill and Roberto Frenkel 99

Table 3.6 External debt as percentage of GDP and of exports

Debt/GDP Debt/exports (%) (%)

1980-81 25 302 1982-83 68 480 1984-86 67 527 1987-88 68 590 1989-90 78 512

Source: Banco Central de la Repdblica Argentina (1985, 1992).

Table 3.7 Public sector savings, investment and financing (% of GDP)

1980 1981 1982 1983 1984 1985 /986 /987 1988'

Total Resources 36.43 35.78 33.07 34.59 33.46 41.52 39.36 36.62 35.74 Current resources 35.53 34.66 32.25 34.12 33.03 40.5 38.24 35.98 34.39 Taxation 23.26 20.35 18.71 18.40 18.19 22.05 22.34 21.14 19.18 Non-taxation 12.27 14.32 13.54 15.71 14.84 18.48 15.90 14.84 15.21 Capital resources 0.31 0.25 0.49 0.23 0.24 0.25 0.21 0.20 0.51 Financial, economic emergency'- - - - - 0.66 0.58 0.11 0.75 Other resources 0.59 0.87 0.33 0.24 0.19 0.08 0.33 0.33 0.09 Total disbursements 43.90 49.03 48.18 49.75 45.38 47.53 44.09 44.51 43.85 Current disbursements 34.39 39.39 39.62 40.06 37.56 40.47 36.61 36.11 36.43 Capital disbursements 9.51 9.65 8.56 9.68 7.82 7.06 7.48 8.41 9.42 Need for financing 7.47 13.26 15.11 15.15 11.92 6.01 4.73 7.89 8.11

Notes: 1. Estimated. 2. Required savings.

Source: INDEC (1985, 1992) 100 Argentina

Table 3.8 Monetary assets in the hands of the public (% of GDP)

Private MI M2 (B and M + on sight (Ml + time deposits) deposits)

1980 7.5 28.4 1981 6.2 28.0 1982 4.8 19.6 1983 3.8 11.2 1984 3.6 10.3 1985 3.5 10.9 1986 5.6 17.1 1987 5.1 18.5 1988 3.3 15.4 1989 2.8 13.2 1990 2.5 5.6 1991 * 4.5 9.0

* Estimated

Source: INDEC (1992).

Table 3.9 Composition of GDP by type of activity (GDP by factor costs, in 1970 australs)

Composition (% GDP) 1980 1990

GDP 100.0 100.0 Goods 46.2 41.3 Agriculture 12.6 15.9 Mining 2.5 3.0 Manufacturing 24.6 20.4 Construction 6.5 2.1 Basic services 14.2 17.8 Electricity, gas, water 3.5 5.5 Transport, storage and communications 10.6 12.2 Other Services 39.7 40.9 Commerce, restaurants and related services 16.2 13.0 Financial, insurance and services rendered to companies 8.9 8.5 Communal, social and personal services 14.6 19.4

Source: Damill and Jelin (1990). Mario Damill and Roberto Frenkel 101

Table 3.10 Balance of payments (million US$)

Current account Real Real Financial Capital Valuation Errors goods services services2 movements adjustments and Balance' omissions} reserves Variation

1980 -4.770 -2.519 -740 -1.531 2.604 -213 -298 -2.677 1981 -4.714 -286 -705 -3.700 1.829 -363 -209 -3.457 1982 -2.358 2.287 43 -4.719 2.107 -106 -400 -756 1983 -2.461 3.331 -440 -5.408 1.463 1.246 -325 -77 1984 -2.391 3.523 -205 -5.712 2.573 -20 -93 69 1985 -953 4.582 -230 -5.303 2.901 -10 -67 1.871 1986 -2.859 2.128 -573 -4.416 1.959 269 68 -563 1987 -4.238 540 -285 -4.485 3.179 170 -222 -111 1988 -1.572 3.810 -255 -5.127 3.474 -27 -90 1.785 1989 -1.292 5.374 -244 -6.422 -357 -5 -45 -1.699 1990" 1.750 8.261 -379 -6.203 839 - 219 2.808 1991" n. a. 4.200 n.a. n. a. n.a. n. a. n. a. n. a.

Notes:

I. The balance of the current account includes unilateral transfers. 2. Includes compensatory capital + non-compensatory capital. 3. Includes gold, foreign currency, realisable funds placed in foreign currency, reserve positions with IMF and special conditions under which to draw against funds. 4. Estimated.

Source: Damill and Keifman (1992).

Table 3.11 Prices of commercial exchange (base index 1970 = 100 of unit values in dollars)

Exports Imports Terms of exchange

1980 302.3 256.9 117.7 1981 311.0 249.6 124.6 1982 258.2 245.4 105.2 1983 232.7 228.4 101.9 1984 246.0 223.0 110.3 1985 219.4 231.0 95.1 1986 194.0 240.5 80.7 1987 186.4 268.7 69.4 1988 218.1 293.2 74.4 1989 233.8 308.9 75.7 1990* 228.0 301.1 75.6

* Provisional data

Source: Ministry of the Economy (1991). 102 Argentina

Table 3.12 Real rates of interest' (equivalent monthly rates in percentages)

Passive2 Active3 Active'

1980 -0.2 0.6 0.6 1981 0.2 1.9 1.9 1982 -2.9 -2.0 --0.2 1983 -2.7 -1.8 3.0 1984 -4.9 -3.7 -0.2 1985 -1.4 0.2 2.9 1986 -1.4 -0.1 0.6 1987 -1.6 -0.2 1.2 1988 -0.9 2.0 0.1 1989 -14.4 -6.6 -5.6 1990 0.4 8.7 8.2 1991 -1.6 4.35 n.a.

Notes: 1. Deflated by the consumer price index (CPI). 2. Until June 1982 and as of 15 October 1987, control rate (weighted average of the rates paid by banks for deposits at 30 days); as of July 1982 and up to 15 October 1987, rate fixed by the BCRA for deposits at 30 days. 3. Until June 1982, average of rates charged by banks to first line clients for loans at 30 days; as of July 1982, regulated rate. As of 15 October 1987, rate applied by Banco de la Nacibn Argentina on discounts of documents at 30 days. 4. Until June 1982. 5. Deflated by the wholesale price index, general level.

Source: Ministry of the Economy (1991).

Table 3.13 Employment by sector (%)

Services and Industry Construction other branches

1970 36.8 7.4 55.8 1975 35.4 6.1 58.4 1980 29.7 9.1 61.0 1985 26.5 7.6 65.9 1987 26.6 6.8 66.6

Notes: Figures for April each year, according to the Information from the Permanent Survey on Households (PSH). The data is for greater Buenos Aires. 'Services and other branches' includes commerce, financial activities. other services and other branches. The latter accounts for between 7 per cent and 8.5 per cent of labour in greater Buenos Aires.

Sources: INDEC (1993); CEPAL (1988). Mario Damill and Roberto Frenkel 103

Table 3.14 Unemployment and underemployment (% of EAP)

Unemployment' Underemployment'

1979 2.6 3.9 1980 2.6 4.5 1981 4.2 5.0 1982 6.0 6.7 1983 5.5 5.9 1984 4.7 5.4 1985 6.3 7.5 1986 5.6 7.2 1987 6.0 8.2 1988 6.5 8.9 1989 8.4 9.3 1990 8.6 9.3 1991 6.43 -

Notes:

1. Rate of open urban unemployment estimated from the PSH. 2. Rate of visible underemployment. The figures for open unemployment and underemployment correspond to estimates for April each year according to the Permanent Survey on House- holds, conducted by INDEC. 3. Greater Buenos Aires.

Source: CEPAL (1990).

Table 3.15 Estimates of functional distribution of income (% of national income)

Total wage bill Adjusted by disbursement Adjusted by for social security social spending

1970-73 43.8 48.7 54.8 1974-75 45.3 50.8 59.7 1976-80 30.3 36.1 43.1 1981-83 29.5 36.9 44.2 1984-87 37.5 44.2 53.1

Sources: CEPAL (1984, 1986); INDEC (1993). 104 Argentina

Table 3.16 Evolution of the tariff structure

1988' 1990 1991 1992

Average tariff (%) 28.86 15.47 18.15 9.73 Average tariff without transitory addit. duties (%) 24.27 13.96 - - Dispersion 13.90 8.92 8.36 9.53 Variability 57.27 64.35 46.04 97.96 Mode 40 24 22 0 Maximum tariff2 (%) 40 24 22 22 Minimum tariff (%) 5 0 0 0 Amount of positions With maximum tariff 2.335 3.020 9.177 3.808 With minimum tariff 849 1.419 1.946 5.165 Total with ad-valorem tariff 10.305 10.247 11.123 11.745 With specific duties Single 117 100 17 0 Minimum 2 225 262 0 In Annex II RME 4070/84' 1.056 27 0 0 With transitory addit. duties 845 800 - 0

Notes: 1. Situation prevailing as of the enforcement of the Canitrot reform, 1988. 2. Does not include tariffs to which transitory additional duties are applied. At present there are no transitory additional duties. 3. Imports subject to prior permit.

Source: CEPAL (1992). Mario Damill and Roberto Frenkel 105

Table 3.17 Public bidding for the Empresa Nacional de Telecommunications (ENTEL - National Telecommunications Enterprise) (millions of US dollars)

Base price Winning offer' Northern zone Cash 100.0 100.0 Documents 177.6 177.6 External debt certificates2 1.635.0 2.308.0 Southern zone Cash 114.0 114.0 Documents 202.4 202.4 External debt certificates2 1.865.0 2.720.0 Total Cash 214 214 Documents 380 380 External debt certificates2 3.500 5.028

Notes: 1. In both zones, the winning offers were those submitted by a consortium comprising Telef6nica de Espaiia, Citicorp and Techint. 2. Includes defaulted payments on interest.

Source: CEPAL (1992).

Table 3.18 Revenue from the privatisation of state-owned companies and public bids for petroleum exploitation areas (million dollars)'

Amount

1990 513 1991 2.177 19922 3.906 19932 880

Notes:

1. The figures do not include the debt certificates used as part of payments in the privatisation operations. 2. Projected.

Source: CEPAL (1990). 106 Argentina

Notes

I . See Appendix 3.1 (pp. 96ff) for a series of tables containing some of the most important economic data for Argentina for the period covered by this chapter. 2. At the economic level, as well as in relation to the political and institutional aspects of the processes of accumulation, it is possible to distinguish several sub-stages in postwar Argentina. While overlooking possible `intermissions', we shall emphasise here, however, some elements of continuity accomplished through the heterodox forms of financing described briefly at a later stage. Basic references for the analysis of this period are Diaz Alejandro (1970), Mallon and Sourrouille (1975) and Canitrot (1975). Cf. also Fanelli and Frenkel (1989a). 3. It must be stressed that neither the financing of growth nor of domestic consumption were the causa prima of the indebtedness the economy displayed at the beginning of the 1980s. This indebtedness originated in phenomena of a fundamentally financial nature, which are described later in this chapter. In this respect, see Frenkel, Fanelli and Sommer (1987). 4. A classical analysis of the political aspects and social conflicts associated with this economic cycle has been developed by O'Donnell (1976). 5. An important element behind this behaviour was the relative success of some policies aimed at promoting non-traditional exports. Industrial exports, which were 3 per cent of the total in 1960, reached 24 per cent in 1975. The anti-trade bias of the import substitution model was becoming increasingly altered. 6. It must be pointed out, however, that substantial measures were not adopted in order to change some of the structural problems already clearly visible in the first half of the 1970s, such as those related to financing the social security system and the industrial promotion regimes. In contra- diction with the anti-state discourse adopted by the economic authority at the time, after an initial reduction in fiscal spending based on wage limitations, there was a strong increase due to a large expansion of public investment. This policy favoured the growth of different entrepreneurial sectors of suppliers and contractors of the state, some of whom were also the beneficiaries of industrial promotion. Military expenditures and those of 'security' increased significantly during this period, as well as those related, for instance, to the ambitious nuclear programme. 7. Among the basic references for the period 1976-81 are Canitrot (1980 and 1981), Feldman and Sommer (1983) and Frenkel (1983 and 1984). 8. When the new plan began in December 1978, the monthly inflation rates were of the order of 9 per cent. However, the correction of the exchange rate was only 5.2 per cent during the first month in which this policy was enforced, well below the inflation of the previous months, and would decrease month by month, tending to zero, according to an announced sequence. It was assumed that the convergence between the internal and external rates of inflation would be reached gradually. 9. The arguments clearly show that the failure of the stabilisation policy based on the monetary approach to the balance of payments was due in great part to the mechanisms adopted in the deregulated markets, within Mario Damill and Roberto Frenkel 107

a context of acute economic and political uncertainty and of a preference for stability by private agents in relation to the composition of their portfolios. Thus the external indebtedness problem in the case of Argentina has little to do with the distortions inherent to the accumulation pattern of the postwar period, even though this is a common opinion of the orthodox perspective. The failure of the financial liberalisation experiment and the line of action then taken by the Central Bank facilitated a change in the composition of private financial portfolios of a magnitude never observed before. The preference of the private agents for liquidity in foreign exchange, repressed under the heterodox accumulation model, could then be carried out, giving rise to an important denationalisation of wealth. Thus the main counterpart to external indebtedness was the holding of financial assets abroad by residents. 10. With respect to this phase, see Fanelli and Frenkel (1987a) and Damill et al. (1988). 11. This was done through different mechanisms, which led to the absorption of a greater part of external private debt by the state and to the socialisation of private domestic debt, which was 'liquified' through the fixing of interest rates at levels far below inflation in an operation designed by the then president of the Central Bank, Domingo Cavallo. 12. Gross national product (GNP) is equal to gross domestic product (GDP) plus the net payments of factors received from abroad by the residents of the country (Z). That is to say: GNP = GDP + Z. By dividing both sides by GDP we have: (GNP/GDP) = I + (Z/GDP). Since Z was very small before the `debt crisis', the ratio between the income that belonged to the residents and the product generated within the Argentinean economy (GNP/GDP) almost reached unity. After the crisis, Z became strongly negative as a consequence of the fact that the high payments of interest to external creditors far exceeded the income from abroad for the payment of factors and international transfers. Naturally the fall in Z in a context of stagnation of GDP involved a strong reduction of (Z/GDP) or, equivalently, an important decline in (GNP/GDP). That is to say, a major part of the flow of income generated in the country was now the property of either foreigners or non-residents. 13. The negative impact of inflation is due to the 'Olivera-Tanzi' effect. Due to the lag between the application and the actual collection of taxes, inflationary accelerations bring about drops in real collection. The opposite is observed in the face of abrupt decelerations in the rhythm of variation of nominal prices. 14. A detailed description of the content of the plan and its effects is to be found in Fanelli and Frenkel (1987a). See also, for instance, Gerchunoff and Cetrangolo (1989) and Machinea (1990). 15. Prior to the launching of the plan there was a strong recomposition of prices (in part induced by the government) establishing a relative price structure that, in the opinion of the authorities, would be in a position to sustain itself over time. 16. In relation to the distinction between these two stages, see Cavarozzi and Grossi (1989). 17. It has been estimated that revenues from the inflation tax throughout the 108 Argentina

period 1980-7 were of a magnitude equivalent, on average, to something more than 6 per cent of GDP per annum (Damill et al., 1989, Chapter 3). 18. Carlos Menem, at the time already in the lead in the pre-electoral polls, announced his intention of carrying out a `salariazo' (a substantial wage increase) at the beginning of his government, as well as declaring a unilateral moratorium on the external debt. At one time he also stated that the Falkland Islands had to be recovered with `blood and bullets'. 19. The hyperinflation process, as well as the stabilisation plans that were implemented one after the other at the beginning of Menem's government, discussed below, are analysed in Damill and Frenkel (1991). 20. Despite the acute macroeconomic disturbances it must be pointed out, however, that one favourable initial condition for the new government had been underway since 1988 in the external trade accounts of the economy. This was fundamentally the reversal of the unfavourable external terms of trade shock the country had suffered in the mid-1980s. In 1989 a commercial surplus of $5.3 billion dollars was attained, which made it possible to reduce the negative balance of current transactions to a level comparable to that of 1985, the lowest attained in the decade. 21. The fall of the real exchange rate during 1991 was surprising due to its magnitude. It continued to fall during the last quarter, when even the nominal parity declined. This brought about a reduction in inflation, but did not attenuate the appreciation of the domestic currency. If real parity is taken to be the base (equal to 100) at the moment at which the Aus- tral Plan was launched in 1985, it is observed that in February 1990 the real exchange rate for industrial exports was 140, though by December of that year it had fallen to 50. 22. The government expected, in fact, a deflation of some importance. The new authorities assumed that it would follow from a reduction in exchange rate uncertainty. The economic authority admitted the exchange rate lag by taking it as a reference in price negotiations with different entrepreneurial sectors, and on defining the adjustment guidelines of the prices of some services, the prices prevailing in the second quarter of 1990. The intent was that the negotiated prices should revert, in March 1991, to the value they had (measured in dollars) in the mentioned `reference' quarter. 23. See Torre (1991), p. 20. 24. This popularity declined from its peak in December 1989 (after having controlled the episode of military insubordination mentioned earlier) to one of its lowest levels only two months later. This was a consequence of the effect of several scandals involving the president's close circle, and the bank run that led to the fall of the minister of finance and his replacement by Domingo Cavallo. However he regained his popularity quickly as an outcome of the good initial results of the Convertibility Plan. Mario Damill and Roberto Frenkel 109

References

Banco Central de la Republica Argentina (1985, 1992) 'Boletin Estadistico', no. 1. Banco Central de la Republica Argentina (1981, 1991) 'Estimaciones Tri- mestrales de Oferta y Demanda Global', 1st trimester. Canitrot, A. (1975) `La experiencia populista de redistribuci6n de ingresos' (The populist experience in redistributing income), Desarrollo Economico, vol. 15, no. 59 (Buenos Aires). Canitrot, A. (1980) `La disciplina como objetivo de la politica econ6mica. Un ensayo sobre el programa econ6mico del gobierno Argentino desde 1976' (Discipline as an objective of economic policy. An essay on the economic program of the Argentinean Government since 1976), Desarrollo Economico, vol. 19, no. 76 (Buenos Aires). Canitrot, A. (1981) `Teorfa y practica del liberalismo. Politica antiinflacionaria y apertura econ6mica en la Argentina' (Theory and practice of liberalism. Anti-inflationary policies and economic liberalisation in Argentina), Desarrollo Economico, no. 82 (Buenos Aires). Canitrot, A. (1983) Èl salario real y la restricci6n interna de la economia' (Real wages and internal restriction of the economy), Desarrollo Economico, vol. 23, no. 91 (Buenos Aires). Canitrot, A. (1992) `La destructi6n del Estado Argentino y los Intentos Pos- teriores de Reconstrucci6n' (The destruction of the Argentinean state and the subsequent attempts at reconstruction), mimeo (Buenos Aires: Torcuato di Tella Institute). Carciofi, R. (1990) `La desarticulaci6n del pacto fiscal. Una interpretaci6n sobre la evoluci6n del sector publico argentino en las dos ultimas decadas' (The disarticulation of the fiscal pact. An interpretation of the evolution of the Argentinean public sector in the last two decades), ECLAC Work- ing Paper Number 36 (Buenos Aires: ECLAC). Cavarozzi, M. and M. Grossi (1989) `De la reinvenci6n democratica al reflujo politico y la hyperinflaci6n (La Argentina de Alfonsfn)' (On the democratic reinvention of the political reflux and hyperinflation [Alfon- sin's Argentina]), mimeo (Buenos Aires). CEPAL (1984) Estudios e Informes de la CEPAL, no. 42 (Santiago de Chile: CEPAL). CEPAL (1986) Èstadisticas de Corto Plazo en la Argentina: Sector Externo y Condiciones Econ6micas Internacionales', vol. 2, Documento de Tra- bajo No. 20 (Buenos Aires: CEPAL). CEPAL (1988) Èstadisticas de Corto Plazo en la Argentina: Cuentas Na- cionales, Industria Manufacturera y Sector Agropecuario Pampeano', vol. 1, Documento de Trabajo No. 28 (Buenos Aires: CEPAL ). CEPAL (1990) 'La desarticulaci6n del pacto fiscal. Una interpretaci6n sobre la evoluci6n del sector publico argentino en las ultimas dos decada', Docu- mento de Trabajo No. 36 (Buenos Aires: CEPAL). CEPAL (1992) Ìndicatores Macroecon6micos de la Argentina' (Buenos Aires: CEPAL, June). Coyuntura Economica Latinoamericana (1990) nos 1 and 2 (Bogota: CLA- DEI-Fedesarrollo). 110 Argentina

Damill, Mario and Jose M. Fanelli (1988) `Decisiones de cartera y transferencia de riqueza en un periodo de inestabilidad macroecon6mica' (Portfo- lio decisions and transfer of wealth in a period of macroeconomic instability), CEDES document no. 12 (Buenos Aires: CEDES). Damill, Mario and Jose M. Fanelli (1989) `El impuesto inflacionario. Me- todologia de calculo y estimaciones para la economia argentina' (Inflationary tax. Methodology of computing it and estimates for the Argentinean economy) CEDES document no. 18 (Buenos Aires: CEDES). Damill, M., J. M. Fanelli, R. Frenkel and G. Rozenwurcel (1988) Las Rela- ciones Financieras en la Economia Argentina (Financial Relationships in the Argentinean Economy) (Buenos Aires: Ediciones IDES). Damill, M., J. M. Fanelli, R. Frenkel and G. Rozenwurcel (1989) Deficit Fiscal, deuda externa y desiquilibrio financiero (Fiscal deficit, external debt and financial disequilibrium) (Buenos Aires: Editorial Tesis). Damill, M. and R. Frenkel (1987) `De la apertura a la crisis financiera. Un analisis de la experiencia argentina de 1977-82' (From liberalisation to the financial crisis), Ensayos Econ6micos, no. 37 (Buenos Aires). Damill, M. and R. Frenkel (1991) `Hiperinflaci6n en Argentina: 1989-90' (Hyperinflation in Argentina: 1989-90)', CEDES document no. 62 (Bue- nos Aires: CEDES). Damill, M. and E. Jelin (1990) 'Sociedad, economfa y politica en Argentina: piezas para armar un nuevo tablero' (Society, economics and politics in Argentina: pieces to put a new board together), mimeo (Buenos Aires: CLACSO). Damill, M. and S. Keifman (1992) 'Liberalizaci6n del Comercio en una Econo- mia de Alta Inflaci6n: Argentina 1989-91', Comercio, Apertura y Dessa- rollo, Pensamiento Iberamericano, no. 21 (Jan.-June, Madrid). Diaz Alejandro, C. (1970) Ensayos sobre historia econ6mica Argentina (Es- says on Argentinean economic history) (Buenos Aires: Amorrortu). Fanelli, J. M. and R. Frenkel (1987a) `El Plan Austral un ano y medio despues' (The Austral Plan a year and a half later), El Trimestre Econ6mico, special issue (Mexico). Fanelli, J. M. and R. Frenkel (1987b) `La Argentina y el Fondo en la decada pasada' (Argentina and the Fund in the past decade), El Trimestre Economico,

vol. LIV, no. 1 (Mexico). Fanelli, J. M. and R. Frenkel (1989a) `Argentina's Medium Term: Problems and Prospects', CEDES document no. 28 (Buenos Aires: CEDES). Fanelli, J. M. and R. Frenkel (1989b) `Desequilibrios, politicas de estabiliza- ci6n e hiperinflaci6n en Argentina' (Economic disequilibria, stabilisation policies and hyperinflation), CEDES document no. 28 (Buenos Aires: CEDES). Fanelli, J. M., R. Frenkel and G. Rozenwurcel (1990) `Growth and Struc- tural Reform in Latin America. Where We Stand', CEDES document no. 57 (Buenos Aires: CEDES). Fanelli, J. M., R. Frenkel and J. Sommer (1987) 'El proceso de endeudamiento externo argentino' (The Argentinean process of foreign indebtedness), Sistema Econ6mico Latinoamericano (Caracas). Feldman, E. and J. Sommer (1983) Crisis Financiera y Endeudamiento Ex- terno (Financial Crisis and Foreign Indebtedness) (Buenos Aires: ET/IPAL). Mario Damill and Roberto Frenkel I I I

Frenkel, R. (1983) 'Mercado financiero, expectativas cambiarias y movimiento de capitales' (Financial market, exchange rate expectations and capital movements), El Trimestre Economico, no. 200 (Mexico). Frenkel, R. (1984) 'Salarios Industriales e inflacion: El periodo 1976-1982' (Industrial wages and inflation: the period 1976-1982), Desarrollo Economico, no. 95 (Buenos Aires). Frenkel, R. (1985) 'Salarios e inflacion en America Latina. Resultados de investigaciones recientes en la Argentina, Brasil, Colombia, Costa Rica y Chile' (Wages and inflation in Latin America: results of recent research in Argentina, Brazil, Colombia, Costa Rica and Chile), Desarrollo Econ6mico, no. 100 (Buenos Aires). Frenkel, R. (1989) Èl regimen de alta inflacion y el nivel de actividad', (The high inflation regime and the level of activity), CEDES document no. 26 (Buenos Aires: CEDES). Frenkel, R. and M. Damill (1988) `Politica de estabilizacion y mercado de trabajo: Argentina 1985- 87' (Stabilisation policy and the labour market: Argentina 1985-87), CEDES document no. 8 (Buenos Aires: CEDES). Gerchunoff, P. and G. Cetrangolo (1989) `Reforms economica y estabilizacion en democracia politica. Examen de una experiencia frustrada' (Econ- omic reform and stabilization in political democracy: review of a frustrated experience), mimeo (Buenos Aires: Torcuato Di Tella Institute). Heyman, Daniel (1986) `Tres ensayos sobre inflacion y politicas de estabi- lizaci6n' (Three essays on inflation and stabilisation policies') (Buenos Aires: ECLAC). INDEC (1985, 1992) Èncuesta Permanente de Hogares' (Buenos Aires: IN- DEC, April). INDEC (1993) Annuario Estadistico de la Republica Argentina 1993 (Bue- nos Aires: INDEC). Machinea, J. L. (1990) 'Stabilization under the Alfonsin's Government: A Frustrated Attempt', CEDES document no. 42 (Buenos Aires: CEDES). Mallon, R. and J. Sourrouille (1975) La politica economica en una sociedad conflictiva: el caso argentino (Economic policy in a conflictive society: the Argentinean case) (Buenos Aires: Amorrortu). Ministry of the Economy (1991) Secretaria de Hacienda de la Nacion Argen- tina, Obras y Servicios Publicos, Circulates de Prensa (Buenos Aires). O' Donnell, G. (1976) Estado y Alianzas en la Argentina 1956-1976 (State and alliances in Argentina 1956-1976), CEDES-CLACSO, no. 5 (Buenos Aires: CEDES). Porto, A. (1975) 'Un modelo simple sobre el comportamiento macroeconomico argentino en el corto plazo' (A simple model on Argentinean short-term macroeconomic behaviour), Desarrollo Economico, vol. 15, no. 59 (Bue- nos Aires). Situation Latinoamericana (1991, 1992) various issues (Madrid: CEDEAL). Torre, J. C. (1991) Àmerica Latina, el gobierno de la democracia en tiempos dificiles' (Latin America, democratic government in times of difficulties), mimeo (Buenos Aires: Torcuato di Tella Institute). 4 An Economist's Political View of Democratisation in Brazil' Edward J. Amadeo

4.1 INTRODUCTION

The current economic and social crisis in Brazil cannot be dissociated from the legacies of the military period (1964-84). The `miraculous' economic performance of the late 1960s and early 1970s and the debt- cum-growth strategy of the late 1970s did have trickle-down effects. In these two decades, and especially in the 1970s, the level of poverty fell and all income groups benefited from economic growth. However, the military governments showed little regard for distributive policies. This is true not only of income distribution, which was strongly affected by the wage policies of the period, but also of the structure of social expenditure, subsidies and transfers, which were quite regressive. From a political point of view the military regime in Brazil was atypical, for although political expression was restricted and the left was repressed, the Congress continued to function for most of the time. Only two parties were legal: the Alianca Renovadora Nacional (ARE- NA), which supported the government, and the Movimiento Democratico Brasileiro (MDB), which, albeit within certain limitations, increasingly opposed government initiatives. The opposition party was an important instrument for channelling political dissatisfaction. From the mid-1970s, economic success showed signs of weakening and the MDB began to challenge the government. Election results tes- tified to the growth of opposition to the military regime. There was always a threat of deepening political repression, but during the presidency of General Geisel (1974-9) a very gradual and controlled process of democratisation was launched. When General Figueiredo took power in 1979 there was an explicit commitment to the opening of the polity. In 1985, a civilian president, Jose Sarney, was elected indirectly through a ballot by members of Congress. The next president, Fernando Collor de Mello, was directly elected in 1989.

112 Edward J. Amadeo 1 13

The economic and social legacy of the military governments had both positive and negative aspects. On the one hand, the growth strategy after the oil shocks was an important step towards the `comple- tion' of the industrialisation process and certainly contributed to the external adjustment of the economy (see Barros de Castro and Souza, 1986). However the growth of external debt and the inflationary impact of attempts to devalue the currency carried the seeds of the economic crisis of the 1980s. The transition to a democratic regime coincided with the emergence of major macroeconomic imbalances on the domestic front. The structure of capital-labour relations and collective bargaining contributed to the macroeconomic imbalance. In the 1980s, the labour union movement developed a remarkable organisational ability, with important consequences for the growth of its bargaining power. Firms were highly protected against foreign competition and employers showed little resistance to wage demands since they could mark up cost increases. This combination of growing bargaining power and a highly protected economy accelerated inflationary pressures. During military rule in the 1970s there were considerable improvements in alleviating poverty and minor improvements in the distribution of income, but, as already mentioned, the military governments showed deep disregard for redistributive and social policies. Because of the social heterogeneity of Brazilian society, the costs of the macroeconomic crisis during the 1980s and early 1990s were unequally shared by different social groups.2 During the 1980s there was an increase in poverty and a sharp regression in the distributive structure. There was a large degree of optimism over the capacity of the democratic governments to improve social conditions and alter the distributive structure. However, as a result of the macroeconomic circumstances and the nature of the political process under which the democratisation of the state took place, redistributive policies have faced severe restrictions. Indeed, ten years after democratisation, the signs of improvement in the social and distributive figures are far from positive. State corporatism and clientelism have been ingrained in the political process in Brazil for decades, including during the military regime, when access to public resources became restricted to a particular set of social actors. Upon democratisation, competition for public resources became even more intense. However, access to the powers of the state had long been limited to a few channels, dominated by privileged societal groups. As a result it has been very difficult to establish let alone implement redistributive programmes. 114 Brazil

Besides the constraints imposed on the establishment of more universal and redistributive policies, corporatism and clientelism also tend to hinder fiscal reform. One of the fundamental elements of the macroeconomic crisis in Brazil is the central government's fiscal deficit, which has been difficult to reduce in the face of opposition to reduced expenditure, increased taxation and attempts to decrease tax evasion. These political and societal problems permeate the Brazilian crisis and cannot be overlooked in an analysis of social and economic crises associated with the democratisation process. This chapter will expand on these points. Section 4.2 presents the `facts' associated with the economic and social heritage of the military regime and the developments in the post-military period, emphasising the macroeconomic crisis, the evolution of distribution of income, the structure of social expenditure and the structure of the education system. Section 4.3 provides an economist's political view of democratisation. I emphasise that it is an economist's view not because this implies anything special but simply that, from the point of view of a trained political scientist, the chapter might very well seem incomplete, trivial or wrong. However, notwithstanding these caveats, the point is that it seemed impossible to attempt an analysis of the issue by discussing it in purely economic terms. Accordingly, Section 4.3 is dedicated to a more speculative and interpretative effort to understand the societal and political aspects of the democratisation process and the restrictions they impose on improving macroeconomic performance and introducing more universal and redistributive policies. A discussion of the societal and political ingredients of the crisis is followed by a look at the back stage of the education drama, identifying its main actors, their attitudes and the political scenario in which they play their respective roles. There are basically two reasons for emphasising education. The first is that the poor education standard of the Brazilian population is central to the unequal distribution of income and wealth, and a fundamental hindrance to economic development in an intensely competitive international environment. The second reason is more pragmatic: the aim is to analyse the politics of the education system in order to illustrate some of the foregoing notions, with emphasis on the conflict between particularistic and universal demands on public resources. The education system is adopted as a case study for its importance and because of the availability of information. Edward J. Amadeo 115

4.2 THE ECONOMIC AND SOCIAL FACTS

The Macroeconomic Background

The macroeconomic performance of the Brazilian economy has been strongly affected by the restrictions imposed on policy alternatives by the oil shocks and the interest rate shock of the early 1980s. Such restrictions implied greater stringency in the trade-offs between the solutions for external and domestic macroeconomic goals.; However successful the external adjustment has been in Brazil, important negative sequels developed in the 1980s during the transition to democracy. Among these, the most prominent were a significant reduction in the capacity of the government to continue to invest in infrastructure and provide social goods, and the acceleration of inflation. The latter resulted from attempts to devalue the cruzeiro in an environment of gradual advancement of indexation schemes. During the 1980s the deterioration of the fiscal situation and the increasing volatility of inflation gave rise to growing uncertainty and, as a consequence, the stagnation of economic activity. The capacity of the government to reestablish fiscal balance, reduce inflation and recover `animal spirits' has declined continuously since the mid-1980s. A series of unsuccessful heterodox stabilisation programmes based on price freezes led to a gradual reduction in the coordinating capability of the government. The clientelist nature of the state in Brazil has also contributed to a decline in the credibility of the government, giving rise to an intensification of the deterioration of social relations. These factors explain the difficulty of establishing an agenda for the post-democratisation period. The democratisation process led, as expected, to a spectacular spread of redistributive demands - in particular on the part of the most organised groups, which had been forced to remain silent during the repressive period of the military regime. The distributive conflict between capital and organised labour became visibly more intense in the 1980s, with significant effects on the course of inflation and the outcome of stabilisation attempts. During the 1970s, the Brazilian economy grew at an average rate of 7 per cent per year. However the terms of trade shocks in 1974 and 1978-9 led to a fragile balance of payments situation, which was considerably worsened in the early 1980s by the surge in international interest rates and the determination of the Brazilian government to pursue a bold investment programme (Tables 4.1 and 4.2). Table 4.1 National accounts

Growth Growth rate Imports Exports Investment Net ext. Interest on Public Private Aggregate rate of GDP per (% of (% of (% of debt ext. debt savings savings savings Year (%) capita (%) GDP) GDP) GDP) (US$Bn) (US$Mn) (% of GDP) (% of GDP) (% of GDP) 1970 - - 7.4 7.0 18.83 4.11 234.00 8.12 11.11 20.54 1971 11.410 8.712 8.2 6.5 19.91 4.90 302.00 7.57 11.03 21.26 1972 11.948 9.281 8.9 7.3 20.33 5.34 359.00 8.69 9.98 21.21 1973 13.943 11.260 9.0 7.8 20.37 6.16 514.00 8.70 11.34 22.04 1974 8.254 5.724 13.3 7.7 21.84 11.90 652.40 6.91 10.95 24.31 1975 5.121 2.673 11.0 7.2 23.33 17.13 1498.00 6.34 14.20 25.70 1976 10.172 7.616 9.4 7.0 22.41 19.44 1809.50 7.35 11.78 23.03 1977 4.928 2.510 7.9 7.2 21.32 24.78 2103.50 7.60 12.15 22.03 1978 4.928 2.510 7.9 6.7 22.26 31.62 2696.40 5.06 14.49 23.03 1979 6.767 4.340 9.3 7.2 23.35 40.22 4185.50 3.47 14.85 23.13 1980 9.108 6.650 11.3 9.1 22.90 46.94 6311.10 4.67 13.22 23.34 1981 -4.393 -6.537 9.8 9.4 22.94 53.90 9161.00 4.28 14.36 23.08 1982 0.574 -1.669 8.3 7.6 21.44 66.20 11353.30 1.40 13.90 21.09 1983 -3.410 -5.545 9.0 11.4 18.13 76.76 9555.40 0.46 12.86 16.68 1984 5.278 2.982 7.9 13.5 16.89 79.10 10202.70 0.26 15.50 15.74 1985 7.946 5.633 7.1 12.2 16.95 84.25 9659.40 -0.22 19.31 19.20 1986 7.583 5.308 6.4 8.8 19.09 95.00 9327.00 2.78 14.35 19.09 1987 3.620 1.453 6.2 9.5 22.30 100.06 8792.20 2.72 19.10 22.30 1988 -0.082 -2.141 5.7 10.9 22.81 93.41 9831.90 1.80 22.29 22.81 1989 3.297 1.212 5.0 8.3 24.86 89.61 9632.90 -1.31 26.40 24.86 1990 -4.037 -5.928 5.5 7.2 21.67 86.57 9.009.00 - 21.18 21.67

Sources: IBGE, National Account Department; BACEN (Central Bank) Bulletins. Edward J. Amadeo 117

Table 4.2 Interest rate, inflation and relative prices

Real exchange Inflation Terms of Year rate IPA-DI IPC-FIPE Interest' Trade rate

1970 86.48 18.50 - - 100.00 1971 84.85 21.40 - - 92.82 1972 85.15 15.90 - - 98.37 1973 85.54 15.50 - - 107.03 1974 87.25 35.40 - 17.32 87.98 1975 89.28 29.30 - 21.84 85.17 1976 87.50 44.90 38.01 41.09 96.32 1977 87.50 35.50 41.18 41.91 112.77 1978 86.73 43.00 39.93 46.44 96.96 1979 93.69 80.10 67.14 42.58 88.98 1980 100.00 121.40 84.77 46.44 73.57 1981 90.45 94.30 90.86 89.26 62.58 1982 91.67 97.70 94.63 119.48 60.87 1983 112.62 234.00 164.06 200.09 60.10 1984 111.00 230.30 178.58 255.56 64.95 1985 114.61 225.70 228.21 276.85 65.09 1986 102.65 62.60 68.08 68.81 97.92 1987 96.61 407.20 367.12 358.00 80.42 1988 84.42 1050.00 900.78 1067.91 80.78 1989 68.56 1748.80 1635.85 2617.93 73.70 1990 60.37 1449.52 1639.08 1412.06 70.21

Notes:

1. US price/Brazil's price 2. Overnight interest rate (annual).

Sources: Carneiro and Werneck, 1991; Getulio Vargas Foundation; FIPE - University of Sao Paulo; BACEN (Central Bank) Bulletins.

In the early 1980s, the Mexican moratorium led the private banks to interrupt the flow of voluntary funds to highly indebted countries, which obviously meant a drastic change in the Brazilian strategy.4 The recession of 1981-3, the import substitution process of the late 1970s and an aggressive programme of incentives to increase exports led to a strong balance of trade from 1984 onwards. This was certainly the positive side of the adjustment. The increase in the external debt resulted on the one hand from the borrowing of state enterprises,' and on the other from the absorption of private debt by the Central Bank.6 Even more important than the amount of registered public debt and private debt absorbed by the Central 1 1 8 Brazil

Bank was the so-called `internal transfer problem', linking the servicing of external debt to the growth of domestic government debt. In order to service the external debt the government had to buy hard currency from the export sector, leading to either an increase in the money supply or the issuing of public debt. Hence the increase in the government domestic debt was directly caused by the servicing of the external debt. The other causes of the fiscal difficulties of the Brazilian government were in some sense associated with the nature of the political process and the particular type of relationship established between the state and society. The structure of subsidies, for instance, was in many cases dictated by ad hoc criteria or political kinship. The replacement of some indirect taxation by direct taxation is universally seen as an instrument to reduce distributive inequities. However an increase in the latter hurts the interests of economic groups with strong political representation in Congress, and this is probably why it has been so difficult to increase the tax base in Brazil. Finally, the number of civil servants swelled in the first years of democratisation and there is clear evidence that clientelist practices (nepotism and favouritism, for example) have dominated the recruitment process in the public sector. All these elements were present during the military period and had important distributive effects. However, since the political system was closed, the macroeconomic effects were somehow restricted. With democratisation the demand for public resources flourished and clientelist practices became pervasive.

Income Distribution

During the military period, rapid economic growth together with the lack of a redistributive strategy resulted in an increase in the level of income of all income groups and a deterioration of the degree of distributive inequality. Data in Barros and Mendonca (1993) furnished the following conclusions. In the 1960s the income of all income deciles increased - the average growth rate of income was 2.2 per cent per annum but there was an increase in inequality, with poorer groups experiencing a smaller increase in income. During the 1970s, the average growth rate of income rose to 7 per cent per annum, with no major changes in distribution. Combining the two decades - which roughly correspond to the military period - the conclusion is that the incomes of all groups increased but there was a deterioration in distribution. The shares in Edward J. Amadeo 119 total income of all groups, except for the two highest deciles, decreased between 1960 and 1980. The share of the ninth and tenth deciles in total income grew from 54.4 per cent to 63.3 per cent. In the 1980s the average rate of increase was -1.5 per cent per annum. The recession of 1981-3 and the inflationary crisis of the second half of the decade were associated with a sharp worsening of inequality: whereas the annual rate of decrease in income of the three highest deciles was around 1 per cent, for the lower deciles it was 4 per cent. The macroeconomic crisis was certainly the primary cause of stagnation in the 1980s. However the deterioration in distribution was also the result of a lack of policies in the previous decades that would have enhanced the capacity of the poorer to cope with the crisis. In particular the failure to establish a social infrastructure for the poor, based on efficient social programmes, should be seen as an important cause of the unequal effects of the economic crisis. We turn to these issues in the following two subsections.

Social Performance and Social Expenditure

Notwithstanding the growth performance of the Brazilian economy in the 1960s and 1970s, the social indicators presented in Table 4.3 provide ample evidence that Brazil has one of the poorest social standards amongst middle-income countries. Compared with its Latin American neighbours (Argentina and Chile), the small Central Ameri- can countries (Cuba and Costa Rica) or newly industrialised countries such as Korea, in 1985 Brazil had the lowest level of life expectancy and adult literacy, and the highest level of infant mortality. It also had the worst income distribution profile. All this reveals the limits of the trickle-down strategy of the military period. Despite the poor social performance, the volume of social expenditure as a .share of GDP or total government expenditure is not small in Brazil. A recent report by the World Bank confirms this by noting that `Brazil's poor social welfare performance does not stem from lower social spending than in other middle-income developing countries. On the contrary, Brazil for several decades has devoted a comparable or higher share of central government expenditure and national product to social sectors than have countries such as Korea and Mexico.' (World Bank, 1988, p. 2). The poorness of the social record stems from the inefficient use of resources, the most important factor being the mistargeting of resources; that is; they generally do not reach the poor. The fact that almost 50 Table 4.3 Social and economic indicators: Brazil compared with middle- and high-income countries

Human Life Infant Under five Ratio of development expectancy Adult mortality mortality Income highest 20% index at birth literacy rate (per 1000 rate (per 1000 share of to lowest Gini (Max 1.00) (years) rate (%) live births) live births) lowest 40% 20% coefficient (1988) (1987) (1985) (1988) (1988) (1975-86) (1975-86) (1986)

Brazil 0.784 65 78 62 85 7 33.7 0.57 Argentina 0.910 71 96 32 37 14 11.3 - Chile 0.931 72 98 19 26 - - 0.46 Costa Rica 0.916 75 93 18 22 12 - 0.42 Cuba 0.877 74 96 15 13 - - - Korea 0.789 70 90 24 33 - - - Portugal 0.899 74 85 14 17 15 9.4 - Australia 0.978 76 99 09 10 15 8.7 - Spain 0.965 77 95 09 12 19 5.8 Italy 0.966 76 97 10 11 17 7.1 -

Source: UNDP 1990. Edward J. Amadeo 121 per cent of federal social expenditure in 1986 was absorbed by social security pension payments to the middle and upper classes - which certainly do not benefit the poorest - provides evidence of this. The inefficiency of the programmes and the burden of administrative costs, due to a widespread lack of qualified civil servants, is another important factor. After the Constitution of 1988 came into effect the federal government's share of social expenditure fell considerably. State and local governments became responsible for the provision of most social services, with the exception of social security and higher education. The decentralisation of these services can be seen as an important move towards greater targeting efficiency if we assume that proximity to those in need reduces the possibility of clientage and bureaucratic waste.'

Asymmetries in the Brazilian Education System

The analysis of the education system in this chapter should be seen as a case study that adds some concrete facts to the analysis. As noted in Section 4.1, there are good reasons for emphasising education. The first is that the poor education standards of the Brazilian population and the high level of inequality in the distribution of education are central aspects of the unequal distribution of income and wealth, and provide a fundamental hindrance to economic development in an intensely competitive international environment. The second reason is associated with the objectives of the second part of the chapter, where we look at the political economy of the transition. After a general discussion of the issue, the aim is to restrict the analysis to the politics of the education system in order to illustrate some of the notions developed previously, with emphasis on the conflict between particularistic and universal demands on public resources. Brazil is plagued by economic and social inequality and education should play an important role in reducing this. However, all evidence leads to the conclusion that asymmetries in the education system have led to an increase rather than a. reduction in social and economic inequality. The asymmetries in the education system were very significant at the end of the military period. The official discourse over the democratisation process in the 1980s emphasised the importance of education in this connection. However, the fiscal crisis at all levels of the government, together with a long tradition of clientelist and corporatist state-society relations, have created obstacles for deeper reforms of the education system. 122 Brazil

There are different dimensions that we could explore in order to describe the structure and asymmetries of Brazil's education system, but we will focus on distributive asymmetries. Table 4.4 provides a starting point for the analysis by comparing income distribution with level of education. It shows very clearly that in 1983 the majority of the students attending state primary schools were at the bottom of the distributive pyramid (approximately 80 per cent came from families earning less than five times the minimum wage), and that the share of poor students fell dramatically to just over 50 per cent for secondary education and less than 24 per cent for higher education. This situation remained throughout the 1980s. Table 4.5 shows the distribution of public expenditure according to educational and governmental levels in 1988. Just 52 per cent of total public expenditure on education was spent on primary education (which accounted for 88 per cent of total enrolments) whereas 39 per cent was spent on secondary education (which accounts for just 3 per cent of enrolments). Information on the structure of Ministry of Education expenditure, which in 1990 accounted for 43 per cent of total public expenditure on education, shows that between 1980 and 1989, after an increase in the share of funds directed to primarily education (from 7 per cent in 1980 to 33 per cent in 1986), it fell to less than 20 per cent in 1988-9. The share of higher education was 65 per cent in 1980, 50 per cent in 1986 and 70 per cent in 1989. At state level, the share of primary education fell after 1986 while the share of higher education increased. The difference in quality between state and private secondary schools is evident from Table 4.6, which shows the percentage of failures, repeaters and graduates by type of school in 1987. The percentage of failures and repeaters in state schools is almost twice that of private schools and the percentage of graduates is 50 per cent higher in private schools. If we recall that the majority of students attending state schools are also the poorest, we can infer that the education system reinforces distributive inequities. The majority of students coming from richer families attend private primary and secondary schools, which are of much better quality than the state schools. Those poor who do go on to higher education go to relatively mediocre private colleges. Assuming that there exists a positive correlation between the performance of teachers and their salaries, the disparity between figures presented in the last two columns of Table 4.6 can at least in part be explained by the differences in salary levels amongst teachers in secondary schools. A study by the World Bank shows that more than Edward J. Amadeo 123

Table 4.4 Income distribution and enrolment in education, 1982 (for children aged 7 and above attending school)

Income Distribution of students by income group classification in public education (%) Primary Secondary Higher l minimum wage 15.3 3.4 1.1 1-2 times the minimum wage 24.6 10.2 4.5 2-5 times the minimum wage 38.5 38.0 18.0 5-10 times the minimum wage 15.3 31.0 26.1 10 times the minimum wage 4.9 16.2 48.3

Source: IBGE (1983).

Table 4.5 Distribution of public expenditure on education according to educational and governmental level, 1988

Primary Secondary Higher Total

Federal 0.09 0.04 0.31 0.43 State 0.32 0.05 0.08 0.44 Municipal 0.12 0.00 0.00 0.12

Total 0.52 0.09 0.39 1.00

Source: Amadeo et at. (1993), p. 33.

Table 4.6 Percentage of failures, repeaters and graduates by type of school, 1987

Failures Repeaters Graduates Year State Private State Private State Private 1970 19.15 12.44 - 0.00 - - 1975 13.65 7.89 6.28 2.70 16.47 22.14 1980 20.48 10.41 10.43 4.08 15.85 23.06 1983 21.72 11.60 12.23 5.71 16.38 25.91 1985 19.20 9.93 12.82 7.31 15.96 26.01 1986 19.31 11.17 13.05 7.40 16.34 24.91 three quarters of teachers in state secondary schools earned less than twice the minimum wage per month (or US $120) in 1988, whilst in private schools more than 60 per cent earned more than four times the minimum wage. 124 Brazil

Based on the above information, we are led to the following conclusions concerning the educational structure that was established during the military period and maintained more or less intact by the democratic governments in the 1980s:

1. Poor students represent the majority in primary and secondary state schools, have a higher level of drop-out, resit and failure than richer students attending private schools, and rarely attend state universities. 2. Enrolment in post-secondary state institutions as a percentage of total enrolment is insignificant, but public expenditure on post-secondary education accounts for more than one third of total public expenditure. 3. Teachers are better paid in private schools, which probably accounts for the better performance of students attending these schools.

Distributive inequities would be reduced if state primary and secondary schools offered better-quality education, the rate of enrolment was higher and the drop-out rate much smaller. This, however, would require a drastic change in the structure of education expenditure in Brazil.

4.3 SOCIETAL AND POLITICAL ASPECTS OF DEMOCRATISATION

Summary and Preliminary Conclusions

The information presented in Section 4.2 above can be summarised as follows:

1. The transition to democracy coincided with a major macroeconomic crisis. The seeds of the crisis were planted in the final years of the military period but elements that were added in the post-authoritarian period cannot be overlooked. The debt crisis, the socialisation of the debt, the internal transfer problem and the regressive tax structure (part of the military heritage) were at the root of the fiscal crisis. Democratisation added to these initial conditions. The growth of demand on public resources intensified after 1988 with the introduction of broad social rights. Edward J. Amadeo 125

2. Democratisation was also accompanied by the growth of an autonomous and very militant union movement. The growth of the bargaining power of unions in the context of a very protected industrial sector gave rise to significant inflationary pressures. 3. The trickle-down strategy of the military period had very limited effects. Both wage policies and the lack of aggressive and encompassing social policies during the military period sharpened distributive heterogeneity. As shown in the analysis of social expenditure and the education system in Section 4.2, no significant changes were made in the post-authoritarian period. Weyland (1991), studying in great detail the social security and tax policies in the first democratic administration, concludes that in these areas important steps were taken to introduce more universalist and redistributive policies.

In this section we shall look at these facts from a political perspective, emphasising the forms of social representation, relations between society and the state, the workings of state bureaucracies and the politics of the education system.

Social Fragmentation and Crisis

There is a lack of social cohesion in Brazilian society. By social cohesion we mean the existence of a set of rather consensual principles guiding the attitude of individuals, social and political institutions and government agencies. The existence of strong conventions and adherence to the law constitute a good proxy for the degree of social cohesion. This is a partial, imperfect and loose definition but probably a useful one. Democracies in rich Western countries are based on the existence of homogeneous societies in which all individuals have the same basic economic and political rights. Homogeneity in an environment of (moderate) growth is probably the source of social cohesion in these societies. The welfare state certainly contributed to making these societies more homogeneous from an economic point of view. However, the introduction of the welfare state was the result of a social contract according to which the economic elites or the dominant groups were forced, or saw the logic of supporting, distributive schemes in order to guarantee political stability. Hence, the interplay of conflicting forces in the poli-tical market were important ingredients in the establishment of homogeneous societies with more or less strong social cohesion. 126 Brazil

Brazilian society is economically heterogeneous, although there have been rare periods of greater social cohesion (for example, during the Goulart government). Furthermore, the state in Brazil has never had an explicit social or egalitarian approach. The rule has always been to focus on growth and to let trickle-down effects play the role of social promoter. These facts cannot be dissociated from the specific forms of relationship between society and the state in Brazil. These forms are characterised by access to public resources based on privileged relations between narrowly based economic groups on the one hand, and politicians and state bureaucrats on the other. In such a relationship, broadly based social representation does not exist. Not only are the forms of representation of social and economic groups (unions and employers associations, for instance) narrowly based but the state institutions (parties, in particular) Lack widespread social support and a long-term agenda. These forms are characteristic of closed, at times democratic, political systems. Clientelism and corporatism are the characteristic forms of relationship between society and the state in the closed political system of Brazil. Weyland (1991, pp. 80-4) associates the origin of state corporatism with the process of 'late-late industrialization' in which the state promoted and directed growth, `fostering the emergence of private business sectors which could undertake industrial ventures.' Seg- ments of the labour force also participated in this effort, which was based on the selection of particular sectors according to the logic of the import substitution strategy, and within the sectors the designation of certain business groups to advance industrialisation. Inevitably this scheme implied the creation of direct links between sectoral representatives and government agencies. Weyland notes that this state-corporatism organized societal categories along narrow, functionally defined sectoral or segmental lines into non-competitive non-voluntary associations which were supervised and controlled by the state' (ibid., p. 81). This type of relationship has been the rule since at least the 1950s, and it is therefore a deeply rooted characteristic of the ties between the state and economic groups in Brazil. Clientelism, on the other hand, is the political face of the narrowly based Brazilian system of state-society relations. It is a `pyramidal system of personal relations between individuals of different status, which is based on the unequal, but reciprocal exchange of particularist benefits and protection for obedience and support' (ibid., p. 82). Clientelism is the name of the game in which Brazilian politicians Edward J. Amadeo 127

exchange votes for small benefits, especially with the poor. The narrowly based system of relations between state and society intensified during the military period. Cardoso (1993) refers to the creation of `bureaucratic rings' involving sectors of the business elites and agencies of the administration. As noted by Cardoso, in their interactions with the bureaucracy and politicians the members of the dominant classes mostly did not represent social or business groups but simply themselves. This, of course, is the most narrowly based form of interest representation. The bureaucratic rings were the instruments of the `privatisation' that took place during the military period. Clientelism and state corporatism are ingrained forms of interest representation and political exchange in Brazil. The military regime strengthened these forms by anchoring its relations with society on bureaucratic rings. The opening of the political system was obviously constrained by past experience. With the end of the military regime other social groups - especially organised urban groups - became important actors in the dispute over public resources and state benefits. There was an increase in universal and distributive demands as exemplified by the broad social rights set out in the new Constitution of 1988. Although there was an increase in the representation of programme-oriented political parties in Congress, the level of fragmentation of both society and the state is still remarkably high. Werneck (1993) uses the term `wretched statecraft' to characterise a situation in which the decay of the state apparatus has reached a point in which it has lost all its coordinating capabilities. Statecraft is defined as the art of conducting state affairs' (ibid., p. 7) and can be measured by the skills and judgments of the technostructure. In the case of Brazil, Werneck notes that `there seems to be a vicious circle at work in which government failures generated by bad statecraft leads to a deterioration of the economic problems which in turn feeds back into even worse statecraft' (ibid., p. 7). Poor statecraft has had disas- trous results, fuelling neoliberal demands for a downsizing of the state. Such demands assume that the size of the state is the relevant issue. However, as argued below, in Brazil it seems that the critical issue is rather the size of the state combined with the characteristics of the state. In discussing the difficulties faced by governments of developing countries when implementing adjustment policies, Frischtak (1993, p. 15) notes that the central problem of the state, and of the governance capacity it encompasses or expresses, is the problem of capture of the state by powerful interest groups. That is to say, the most important 128 Brazil challenge facing any state is its survival, and the primordial condition of state's survival ... is that of maintaining a minimal degree of autonomy from the competing pressures of society' (emphasis added) Governance depends on the capacity of the state to avoid being cap- tured by powerful economic interests that substantially reduce its àbility to project a culturally bound vision of ... society' (ibid., p. 25). Lack of statecraft and lack of governance are certainly important dimensions of the crisis in Brazil. But what seems to be particularly relevant in the case of newly democratic heterogeneous societies such as Brazil is the conflict between particularist and universal demands, or the conflict between the past and present. The past is characterised by a development strategy based on an exceptionally segmented and exclusive access to public resources. The present is characterised by demands to broaden the access to public resources. The social matrix involved in the dispute between segmented and universal demands is very complicated. Not only would the business elites and the upper middle class have to reduce their demand for public resources but also segments of the urban middle classes, including salaried state employees, would have to waive certain privileges in favour of more universal and encompassing initiatives. The macroeconomic crisis and the intense competition for public resources have led to a gradual disorganisation of the state in Brazil. At certain times in the recent past the situation has reached chaotic levels.The state cannot accommodate clientelist, corporatist and universal demands at the same time, and the conflict between these types of demand given the budget constraints, has led to an overloaded and unattainable agenda and to the fiscal crisis of the post-authoritarian period. Werneck (1993, p. 8) notes that if the rate of growth of GDP in Brazil during the 1980s and the first half of the 1990s were to continue at the pace of the previous four decades, per capita income in 1995 would be around US$6300 instead of the US$2800 that will probably be observed then. These figures provide an idea of the change in expectations over the last decade. The high degree of social mobility through trickle-down effects in an economy growing by 7 per cent a year for four decades tends to remove political opposition to the en- throned elites. An abrupt change in expectations, however, leads to an abrupt change in attitudes. There are two possible responses to the new lack of opportunities: either an èxit' response, characterised by open disregard for the established order (or non-recognition of the state), or a `voice' response characterised by a greater demand for political Edward J. Amadeo 129 and economic participation. It is the latter response that gives rise to the crowding-out of clientelist and corporatist demands. The exit response assumes different forms. A mild form is tax evasion. The extreme response is manifested by illegal and violent activity, such as the drug trafficking kidnapping and so on that characterises suburban areas of large cities in Latin America. In discussing the democratisation of Brazil, Peru and Argentina, O'Donnell (1993) provides a vivid picture of the process of societal decay in those countries. He notes that in `many emerging democracies, the effectiveness of a national order embodied in the law and the authority of the state fades away as soon as we leave the national urban centers' (O'Donnell, 1993, p. 6). He then associates the lack of effectiveness of the law and the authorities with the development of personalist, nepotist and clientelist relations, to the fragmentation of society in feuds, and to the invasion of the state by particularist interests' representatives. He argues that the state that results from this process is representative and is `consistent with the reality of countries whose patterns of political representation further heterogenizes them. The problem is that this representativeness entails the introjection of authoritarianism - understood here as the denial of the publicness and of the effective legality of a democratic state and, hence, of citizenship - at the very center of political power of these countries' (ibid., p. 9).8 In line with the points being raised here, Santos (1993) shows the simultaneous process of forming a `poliarchic' state and an increasingly `Hobbesian natural state of society' in Brazil. The former is associated with the increase in political participation. The latter results from a rapid process of `social transformation' and is characterised by the ìnexistence of universally accepted general norms' (Santos, 1993, p. 109). He also refers to the fragmentation of society that is associated with the uncertainty that characterises periods of rapid transformation. In discussing the growth of unlawful activities or the lack of `stateness' it is worth recalling Weber's views on obedience to the laws. He notes that the inclination to forego economic opportunity simply in order to act legally is obviously slight, unless circumvention of the formal law is strongly disapproved by a powerful convention' (Weber, 1968, p. 335). Conventions, in turn, are strongly associated with social cohesion, or the level of agreement on the principles forming agents' attitudes, and are said to exist whenever a certain conduct is sought to be induced without ... any coercion ... and without any direct reaction other than the expression of approval or disapproval on the part of those persons who constitute the environment of the actor' (ibid., 130 Brazil p. 319). Economic and social desegregation destroys the system of conventions and therefore reduces adherence to the laws. In such circumstances, state coercion might be an inefficient instrument to induce compliance with the laws. The recent experience in many Latin Amer- ican societies adds weight to such a view. We have come full circle. The thesis defended here is that the survival of the narrowly based political system in Brazil in the 1960s and 1970s was due to economic growth (and social mobility) and the repression of opposition forces. The opening of the polity together with the weakening of economic dynamism led to a fundamental conflict between the old clientelistic and the new universal demands for public funds and government initiatives. Amongst the effects of such conflict are the reduction of the coordinating power of the state (loss of statecraft and governance) and the spread of unlawful activities (lack of `stateness'). However, the personalist, nepotist and clientelist relations established around these unlawful activities pervade the state, thus enhancing the particularist nature of government initiatives. The end result is the furthering of the fragmented interest representation system and the weakening of broad-based or encompassing forces.

Inside the Education System

We now turn to a particular area where government initiatives in the distribution of public resources is crucial - education. The discussion is framed within the context of government budget cuts that result from the necessities imposed by macroeconomic constraints - the typical situation faced by governments in Latin America in the 1980s. The questions posed are: who will pay for the adjustment, or who will lose out because of the cuts?' and to what extent will universal initiatives based on equity principles survive the attack of particularist forces?'9 This subsection starts with a general discussion of the capacity of different actors to respond to budget cuts. It then looks at the specific case of education in Brazil, and finally examines the role of bureaucracies in determining the directions taken by government initiatives. As noted in Section 4.2, the fundamental asymmetries in the Brazil- ian education system are associated with the distributive profile of students and the distribution of public resources amongst different levels of education. In the light of these asymmetries we will take the protection of primary and secondary state education against budget cuts, and the increase in the absolute level of funds directed to these two levels of education as typical examples of universalist initiatives, or Edward J. Amadeo 131 initiatives to increase equity. We will argue that the action of pressure groups and the workings of bureaucracies may have an important role in determining the distribution of funds. The ability of groups affected by cuts in government expenditure to respond to or resist the change depends on three aspects, which could be referred to as (1) command over resources, (2) degree of organisation and (3) the strategy adopted by the group. Firstly, the typical case of command over resources refers to capital or material wealth. The richer the individual or the group, the greater the possibility of effectively reacting to the losses brought about by the change. However other types of resource are available to an agent. One is access to information, brought about by privileged relations, educational background or social extraction. The other is social prestige, which depends on a number of cultural factors. Secondly, agents with similar interests may organise into groups, which depending on the coherence of their goals and the costs of finding a solid strategy, enables them to fight against decisions that might be deleterious to the quality of their lives. The coherence of interests and the costs of organising members in critical moments are the internal factors that determine the degree of effectiveness of the organisation. Thirdly, the strategy followed by each group varies in accordance with its command over resources and its degree of organisation. Not all strategies are available to all individuals or groups, which is obviously an important factor in analysing the diversity of responses. In order to be economical in the usage of concepts, we adopt Hirshman's notions of `exit' and `voice' as a way of differentiating the strategies. In the face of a deterioration in the quality of a good or service, Hirshman (1970) argues that individuals may either choose an alternative (sub- stitute) source of the good or service in question - this is the exit strategy - or try to induce a reversal of the trend by voicing their dissatisfaction."' These three aspects can be represented as follows:

Capacity to respond to adverse situations Degree of organisation High Low

Command over Large: exit/voice Exit resources Small: voice (Passivity) 132 Brazil

Exit is a `market response' (Hirshman, 1970, p. 15); that is, the individual or group prefers to go to another producer of the good or service even if this decision involves a greater financial cost, which implies the necessity of some command over material resources. Voice, on the other hand, is a `political response' par excellence, and therefore requires some organisation. The availability of resources may be of great help in engaging in a voice strategy. However, depending on the situation or the costs involved in giving voice, an organised group with large command over resources may choose to exit. Hence an organised group with resources may either exit or give voice. This is the only group for whom both strategies are feasible. An organised group without resources has only the possibility of voicing its dissatisfaction. This is probably the reason why agents without resources organise more frequently than those who do have resources." Hence, for the poor, who are the ones to suffer most from the effects of budget cuts in social expenditure, organisation is an essential weapon. Those who are deprived of resources and are not organised have no alternative but to accept passively the effects of the change in the state of nature. Probably the most perverse distributive effect of budget cuts in education is the deterioration of basic state education. The reason for such an outcome is associated with the fact that, in general, the degree of organisation of the consumers (families) is very low due to their lack of resources. In the face of a deterioration in the quality of the service, those with financial resources (rich families) tend to exit the public system. Poor families have no choice but to accept passively the effects. In Brazil, state universities offer better education than most private institutions. Hence exit is not an alternative. This provides an incentive for organisation and voice, and may be the reason why university students are relatively more organised. As for the suppliers (teachers and administrative staff), in many cases their action is ineffective or they have a passive attitude, for their degree of organisation tends to be low and their command over resources small. In the city of Rio de Janeiro, primary and secondary school teachers can go on strike for months without any practical consequences: relatively rich families do not send their children to state schools, thus reducing significantly the potency of strike action. Bureaucracies also have an enormous influence on the direction of budget cuts. They have their own ideas of the kinds of service their constituents need and they may disagree with those of their bosses or even with those of the consumers of their services. Here we may have Edward J. Amadeo 133 different situations. High-level bureaucrats that deliver services to remote and passive clienteles may indeed have agendas that significantly differ from what the recipients would want. This may be due to sheer igno- rance, but often it is a deliberate policy. With more proximate and participative clienteles, a closer relationship tends to develop between bureaucrats and their constituencies. In fact the relationship may be symbiotic, with bureaucrats operating in close collaboration with their constituents in order to protect their budgets. Bureaucrats may warn their `customers' that they should protest and finetune the timing and mode of doing so. The next question is: what makes for strong organisations inside public bureaucracies and in what way do they act differently from others? The first mechanism that comes to mind is the existence of a high degree of homogeneity between constituencies and the groups that represent them. Very often primary schools are represented in national governments by primary school teachers. University departments in ministries are often staffed exclusively by university professors. Re- search coordinating departments are full of scientists. Usually scientists are better fundraisers than primary school teachers. Higher education institutions are also more keenly aware of the need to send their best and more aggressive staff to work at the central ministries. The end result is that better organised, better staffed groups are better represented in the ministries. In fact, these institutions are convinced that sending good people to the central bureaucracies is an effective way of protecting their interests. And for all we know, they may be right. Both the forces of political pressure and the workings of bureaucracies explain the asymmetric distribution of budget cuts in education. In the case of Brazil they seem to be important forces in explaining the difficulty of adopting more universal principles in decisions affecting the education system, as in other areas in the post-military period.

4.4 CONCLUSIONS

The economic crisis in Brazil coincided with the transition to democracy. However, the crisis is not a direct consequence of either the military regime or the process of democratisation itself. It is, on the one hand, the result of the debt crisis, which in a sense was externally determined. On the other hand, and certainly much more importantly, the crisis is a result of the nature of the relationship between the state and social groups in Brazil. It is not really a problem of mismanagement, 134 Brazil although in recent years a lack. of statecraft may be held responsible for part of the crisis. Neither is it a crisis of the state itself. It is rather a societal crisis that strongly interferes with the workings of the government and other state institutions. What do we mean by this? In Brazil, as in other Latin American countries, it is commonly accepted that the state has caused the crisis by being too large and too inefficient. Our point is that the state is not too large, given the redistribution of income required to reduce heterogeneity and increase social cohesion. The market is unable to perform such a task. The state's inefficiency may not be due to civil servants' lack of managerial competence - after all the state in Brazil was very efficient until the late 1970s - but rather to a lack of consistent objectives, given the means at its disposal. The critical issue is that there is an inconsistency between the level of demand for public resources and the budget constraint faced by the government. It is important to increase the tax burden in order to relax the budget constraint. But it is also important to understand that a fundamental conflict exists between clientelist and sectorally oriented use of public funds and the universal demands required to promote the redistribution of income. If democracy were to be held responsible for the crisis in Brazil, it is not because democracy is inconsistent with good economic performance, as illustrated by the advanced OECD countries. However, it might be that democracy is somewhat incompatible with good economic performance in more heterogeneous societies. Recall that not only in Latin America but also in Spain and Portugal in the 1970s, democracy seemed inappropriate. The reason might be that in democracies conflicts arise between particularist and universalist demands. The crisis in Brazil is neither a crisis of the state nor a purely economic crisis. It is rather a crisis brought about by increasingly participatory democracy in an extremely heterogeneous society.

Notes

1. I benefited from conversations on related issues with Jose Marcio Camargo, Gustavo Franco, Hans Mathieu and Kurt Weyland. The work of Weyland was particularly important for the development of my arguments. 2. See Amadeo et al. (1993) for an analysis of the impact of the crisis on the labour market and the sharing of the costs among different labour groups. Edward J. Amadeo 135

3. Tables 4.1 and 4.2 present the figures mentioned in the following paragraphs. 4. Foreign borrowing was an important factor in the deepening of the import substitution process in the 1970s and early 1980s. The surge in international interest rates led to a 100 per cent increase of the external debt in five years, rising from US$54 billion in 1980 to US$102 billion in 1986 (Table 4.1). Interest on the debt went from an average of US$3 billion in the second half of the 1970s to US$9 billion in the second half of the 1980s (Table 2.1). 5. The state enterprises played an important role in the adjustment effort of the late 1970s, financing part of their investments with external funds. 6. The decision to absorb the private external debt was intended to protect private borrowers from the exchange rate and interest rate shocks. In reducing the risk of the private borrowers, the government implicitly socialised the debt. 7. On the other hand, the transfer of tax revenues to the states and local governments was not followed by an equal transfer of the responsibility for the corresponding social services delivered by the central government. As a result of this imbalance, since 1988 the central government has had serious budgetary problems. 8. Perhaps O'Donnell deliberately chose not to discuss the economic and political origins of the process of societal decay that he describes, but it is a pity that such analysis is lacking in the text. 9. What follows draws freely from Amadeo et al. (1990). 10. The following passage clarifies the two notions: To resort to voice, rather than exit, is for the customer or member to make an attempt at changing the practices, policies, and outputs of the firm from which one buys or of the organization to which one belongs. Voice is here defined as any attempt at all to change, rather than to escape from, an objectionable state of affairs, whether through individual or collective petition to the management directly in charge, through appeal to a higher authority with the intention of forcing a change in management, or through various types of actions and protests, including those that are meant to mobilize public opinion' (Hirshman, 1970, p. 30). 11. Workers have a greater incentive to organise than employers; blue-collar workers a greater incentive to organise than white-collar workers, and so on.

References

Amadeo, E. J. and T. Banuri (1991) `Policy, governance and the management of conflict', in T. Banuri (ed.), Economic Liberalization: no pana- cea (Oxford: Clarendon Press). Amadeo, E. J., R. P. Barros, J. M. Camargo, R. Mendonca, V. Pero and A. Urani (1993) `Human resources in the adjustment process: the case of Brazil', mimeo (Washington: IDB). Amadeo, E. J., J. M. Camargo and C. M. Castro (1989) The political economy 136 Brazil

of budget cuts', Discussion Paper no. 73 (Geneva: Training Policies Branch, ILO). Amadeo, E. J., J. M. Camargo, A. E. Marques and C. Gomes (1990) 'Fiscal crisis and asymmetries in the educational system in Brazil', mimeo (Gene- va: Training Policies Branch, ILO). Barros, R. P. and R. Mendonca (1993) `Evolucao do bem-estar e da desigualdade no Brasil desde 1960', in BNDES, Desenvolvimento economico, investimento, mercado de trabalho e distribuicao de renda (Rio de Janeiro). Barros de Castro, A. and F. E. P. Souza (1985) A economia brasileira em marcha forpada (Rio de Janeiro: Paz e Terra). Cardoso, F. H. (1993) A construcao da democracia (S. Paulo: Editora Siciliano). Carneiro, D. D. and R. Werneck (1991) `Public savings and private investment: requirements for growth resumption in the Brazilian economy', mimeo (PUC-Rio: Department of Economics). Frischtak, L. L. (1993) 'Antinomies of development: governance capacity and adjustment responses', working paper (Washington: Private Sector Development Department, World Bank). Hirshman, A. (1970) Exit, voice and loyalty (Cambridge, Mass: Harvard Uni- versity Press). IBGE (1983) Annuario Estatisticodo Brasil (Rio de Janeiro: Government of Brazil). O'Donnell, G. (1993) On the state, democratization and some conceptual problems', Working Paper no. 192 (South Bend, Indiana: Kellog Institute, University of Notre Dame). Santos, W. G. (1993) Razoes da Desordem (Rio de Janeiro: Rocco). UNDP (1990) The Human Development Report (New York: United Nations). Weber, M. (1968) Economy and society (New York: Bedminster Press). Weffort, F. (1991) `Democracia politica e desenvolvimento economico', in F. Weffort et al., A democracia como proposta (Rio de Janeiro: IBASE). Werneck, R. F. (1993) 'Government failure and wretched statecraft: lessons from the Brazilian vicious circle', Discussion Paper no. 301 (PUC-Rio: Department of Economics). Weyland, K. (1991) `Democracy and equity: redistributive policy-making in Brazil's new republic', unpublished Ph.D dissertation, Department of Political Science, Stanford University. World Bank (1988) Brazil: public spending on social programs, issues and options, report number 7086-BR, 2 vols (Washington: World Bank). 5 Democratic Restoration and Economic Policy: Uruguay 1985-89 Luis Macadar

5.1 INTRODUCTION

In March 1985, after more than a decade of military rule, Uruguay returned to democracy. It did so determined to restore and consolidate the full functioning of the democratic institutions that had been such a distinctive feature of its history. However, authoritarianism bequeathed a complex and difficult future. In 1985, the economy was still in a state of exceptional crisis. To solve the huge inherited economic problems, as well as to meet, even partially, the expectations aroused by democratic restoration, would have been a difficult task for any government. Yet, in addition to these problems, the economic context was quite different from that prevailing before 1973: the traditional priorities of Uruguayan democracy vis- a-vis the operation of the economy had altered; the relative weight of the various economic actors had changed; and the country was ad- vancing towards integration with the international economy. This chapter studies the economic policies applied during the first five years (1985-89) of the democratic administration that followed dictatorship, in order to distinguish them from the policies applied in the previous period. The analysis focuses on the performance of the economy during these years.

5.2 MAJOR TRENDS

The Uruguayan economy has an agricultural structure based on livestock production.' Pasture-based, extensive livestock production has constituted Uruguay's main competitive activity in the century or more of its history as a capitalist economy. Under the livestock export model, Uruguay was integrated quite early into the dynamics of the world

137 138 Uruguay economy, supplying industrialised countries with wool, beef and hides. Favourable natural conditions, together with the constant improvement of livestock production and growing foreign demand, fostered the large expansion of livestock production destined mainly for export. The general decline of international trade resulting from the 1929 crisis produced a serious imbalance in the country's external accounts, which prompted Uruguay, like many other Latin American countries, to close its economy. Instead it fostered and promoted industrialisation while also protecting its domestic activities. A new phase of economic expansion based on import-substituting industrialisation was to pro- ceed until the end of the 1950s. The shift coincided with the long-run stagnation of output in the livestock sector. Industrial growth brought about both increasing diversification of the productive base and the restructuring of imports. However, since the new policy was aimed at supplying the domestic market, diversification of production was reflected in neither the level nor the structure of exports. Due to the accelerated growth of vital imports for the industrial sector and the stagnation of exports from the livestock sector, a large external gap gradually emerged. This gap was soon to become the principal constraint of this second growth phase. Industrialisation was supported by an enlarged domestic market, created by means of incomes policy, aimed at the middle and working classes, as well as by legislation favouring industrial capital. At the same time an uneasy state of equilibrium was maintained with the landowning class. The structure of competing interests became increasingly complex, including representation for the interests of the industrial groups and of the urban working and middle classes, within a state system managed by an extremely complicated apparatus of political parties operating through arbitration and bureaucratic clientelism. By the mid-1950s economic growth, political stability, high levels of income and its relatively equitable distribution seemed to confirm the image of Uruguay as an exceptional country within the Latin Ameri- can region. However, from 1955-9 economic and social indicators began to deteriorate sharply. This marked the beginning of a stagnation in output that lasted almost fifteen years. Capital shifted away from the productive sectors and was placed in commercial, financial and speculative ventures. As a result, the industrial sector, which had lost most of its previous appeal to investors, suffered the same fate as the livestock sector: low levels of investment impeded its modernisation. The exhaustion of the growth pattern resulted in the stagnation of output, which in turn led to severe internal and external imbalances. Luis Macadar 139

From 1959 onwards there were repeated attempts to return to a pattern of exports from the livestock sector, but the increase in demand and in international beef prices only resulted in a moderate expansion of livestock production. However this expansion came to an abrupt end with the outbreak of the 1974 oil crisis, which coincided with the closure of foreign markets and a fall in beef prices. Uruguay was then plunged into a major economic crisis. Following the 1973 coup d'etat, the military government was obliged to implement a new growth pattern, once again led by the industrial sector. Using a variety of policy instruments, an export-promotion policy was adopted, which resulted in a change in the structure of relative prices and led to a strong increase in the profitability of industrial exports. External competitiveness, achieved through the granting of incentives, made possible a rapid penetration of Uruguayan manufactured products into world markets. Though unevenly applied, this pattern of export-diversifying industrialisation became characteristic of the Uru- guayan economy from the beginning of the 1970s. Manufacturing based on the processing of agricultural products became a distinctive feature of the new growth phase. From 1978 onwards external sector liberalisation was accelerated, particularly with regard to financial activities. Foreign capital inflows - especially from Argentina - increased sharply, greatly benefiting the construction sector and leading to a build-up of financial assets. The development of these and other activities was also linked to the abundant availability of financial resources in general, which characterise this period throughout Latin America. A proposal to convert the country into a regional and international financial centre began to be promoted. Massive inflows of financial capital coupled with high interest rates led to a new functioning of the economy. The project of industrial export-led growth was temporarily postponed, as high financial costs proved to be incompatible with profitable production. Economic policy supported these trends: it reduced incentives to production - irrespective of its destination - while adopting an exchange-rate policy that led to increasing overvaluation of the Uruguayan currency.

5.3 THE LEGACY OF THE CRISIS

By the end of 1981 the country was facing one of the worst crises in its history. Output, employment and wages all fell sharply, the balance 140 Uruguay of payments had deteriorated, inflation accelerated rapidly, and foreign and domestic indebtedness reached dangerous levels. The Uruguayan economy underwent two years of deep recession. Factors inherited from this crisis were at the core of the problems to be faced by the constitutional government in March 1985. Between 1982 and 1984 GDP fell by 16 per cent (Table 5.1). The situation was even more serious for the manufacturing industry: between 1981 and 1983 industrial production dropped by 26 per cent, worse than in any other Latin American country during the same period. Unemployment rose from 6 per cent in 1981 to peak at 16.5 per cent in 1983, although international emigration simultaneously accounted for 10 per cent of the Uruguayan working-age population. Real wages, which had already fallen significantly during the military dictatorship, dropped almost 30 per cent between 1982 and 1984 (Table 5.2). Dom- estic demand dramatically decreased because of a total decline in investment and consumption of 26 per cent, bringing manufactured goods consumption down to half the level reached in 1980 (Macadar, 1987). Investment has traditionally been extremely weak in Uruguay, usually one of the lowest levels relative to GDP in all of Latin America. Be- tween 1981 and 1984 investment fell by almost 50 per cent; during the same period consumption fell by 14 per cent. During the 1970s Uruguay's chronic deficit in the trade balance was overcome by large capital inflows. After 1983 foreign trade balances were favourable, and therefore the current account deficit was greatly reduced. This adjustment was achieved by means of an unprecedented reduction of imports (60 per cent), largely the result of a strong decrease in the level of activity. By 1981 Uruguay had balanced its fiscal budget. However in 1982 fiscal accounts became highly unbalanced as a result of a sharp reduction in revenues and a steep increase in public expenses. In 1982 the deficit climbed to 18 per cent of GDP. One year before the installation of the elected government, the cu- mulative gross external debt amounted to nearly US$5 billion, which was almost equivalent to one year's GDP and five years' exports. Interest payments accounted for 8.5 per cent of GDP, an historically unprecedented transfer of wealth abroad (Couriel, 1988). This debt tripled in only four years (1979-83), which added to the productive sectors' overindebtedness and moved conventional indicators to critical levels. By a preannounced minidevaluation (the tablita, in Rio de la Plata jargon) dictatorial decision makers persisted in applying an exchange- rate policy that resulted in a significant overvaluation of local cur- Luis Macadar 141 rency. A remarkable capital flight, which reached almost US$1.2 billion, an amount equivalent to one third of the total external gross debt, caused a significant loss of international reserves. A process of indebtedness quickly followed, while a substantial number of deposits in local currency were withdrawn from banks in order to purchase foreign currency. This led to short-term borrowing by the monetary authorities in order to maintain the external payment flow and the exchange- rate parity. In other words, the rapid increase in external debt can be explained by the growth of public indebtedness in order to cover private capital flight. In November 1982 the preannounced exchange rate was abandoned and a floating exchange-rate system was adopted. This brought about a dramatic devaluation; the exchange rate value tripled and immediately multiplied firms' debts. The consequences were the insolvency of borrowers, followed by bankruptcy and the closing down of quite a number of firms. The financial difficulties of several agrarian, industrial and commercial firms further endangered the banking system. The Central Bank then decided to assist the latter in order to avoid a financial collapse, thus contributing to a transfer of private debts to the public sector. They bought non-collectable assets, granted refinancing to debtors, exempted them from interest payments and promoted the sale of insolvent banks. Several of the latter became the property of the state. In effect, private debt ended up becoming state-owned. As a consequence of the tablita experience, the competitiveness of Uruguayan production deteriorated substantially. Government operations faced serious restrictions, and future economic policy options were severely constrained. Financial liabilities taken up by the state were a large proportion of government expenditure and were thus a heavy burden on the new government.

5.4 THE ECONOMIC POLICY OF THE CONSTITUTIONAL GOVERNMENT

The new democratic government had to face economic difficulties at two levels: first, the accumulation of structural difficulties, which were already severe by the 1970s; and second, the legacy of the crisis that began in 1982. In the face of a semiparalysed economy, the immediate challenge was to restore economic agents' confidence, reopen political and social dialogue, and recover production in a very complex international context. Table 5.1 Uruguay: main macroeconomic indicators

Gross national product Change in GNP Sectoral structure of GNP

Total Population per capita Total Population Per Capita Agric. Industry Const. Services Years (mill.N$) (1000s) (N$) (%) (%a) (%) (%) (%) (%) (%)

1970-73* 25 703 2 816 797 9 125 -0.36 0.15 20.50 15.85 21.32 4.08 58.74 1974-78* 28 734 2 847 529 10 088 3.87 0.41 3.45 12.69 24.18 4.49 58.64 1979-81* 34 372 2 914 135 11 793 4.67 0.61 4.04 10.89 25.35 5.33 58.43 1982-84* 30 737 2 970 092 10 351 -5.62 0.64 26.22 10.35 23.11 4.00 62.55

1985 29 905 3 008 269 9 941 0.30 0.64 0.34 12.18 25.81 2.07 59.95 1986 32 148 3 025 264 10 627 7.50 0.56 6.90 12.22 24.76 2.18 60.84 1987 34 048 3 042 356 11 191 5.91 0.56 5.32 12.10 25.82 2.51 59.58 1988 34 217 3 059 545 11 184 0.50 0.56 20.07 11.10 23.58 2.61 62.68 1989 34 730 3 076 830 11 288 1.50 0.56 0.93 10.78 22.25 3.20 63.78

1985-89* 33 010 3 042 453 10 846 3.10 0.58 2.50 11.68 24.44 2.51 61.36 1985-87* 32 034 3 025 296 10 586 4.52 0.59 3.91 12.16 25.46 2.25 60.12 1988-89* 34474 3 068 188 11 236 1.00 0.56 0.43 10.96 22.92 2.90 63.23 Table 5.1 continued

Change in sectoral GNP Gross fixed invest. Labour market

Agric. Industry Const. Services Variat. % of GNP Participation rate Unemploy. rate Employm. (%) (%) (%) (%) (%) Total Men Women Total Men Women rate

1970-73* -4.96 0.41 -4.53 0.65 -10.84 10.35 48.3 72.2 28.2 7.9 7.3 9.4 44.5 1974-78* 0.97 4.43 17.30 3.35 19.59 14.04 51.7 72.9 34.6 10.7 8.0 15.2 46.4 1979-81 * 6.28 1.54 6.31 5.38 7.07 16.19 53.9 74.0 38.2 7.5 5.9 11.1 48.7 1982-84* -4.19 -7.39 -16.93 -4.48 -20.84 11.78 57.3 74.7 43.2 13.7 10.6 18.5 49.2

1985 4.56 -1.61 -30.12 1.87 -23.23 7.42 58.5 75.1 45.0 13.1 10.2 16.9 50.8 1986 4.43 12.10 5.33 6.81 12.64 7.95 58.5 75.6 45.0 10.7 8.2 14.2 52.2 1987 2.97 12.40 10.12 4.22 19.60 9.12 60.2 76.9 46.8 9.3 6.8 12.5 54.6 1988 1.68 -3.70 3.92 1.87 4.05 9.55 59.3 75.5 46.2 9.1 6.7 12.2 53.9 1989 0.98 -2.14 11.70 2.43 -1.33 9.38 59.5 75.1 46.9 8.6 6.7 11.0 54.5

1985-89* 2.92 3.16 -1.21 3.42 1.21 8.68 59.2 75.6 46.0 10.2 7.7 13.4 53.2 1985-87* 3.98 7.43 -6.76 4.28 1.13 8.16 59.1 75.9 45.6 11.0 8.4 14.5 52.6 1988-89* 1.33 -2.92 7.74 2.15 1.32 9.46 59.5 75.3 46.6 8.9 6.7 11.6 54.2

* Annual averages.

Sources: Based on information from the Banco Central of Uruguay and the Direccion General de Estadistica y Censos. Table 5.2 Uruguay: main external sector indicators

Foreign trade Degree of openness Balance of foreign trade

Goods & Current Balance in Terms Interest on Variations in quantities Percent of GNP Goods services account goods of external debt Year Exports Imports Exports Imports Exp+lmp (millions of dollars) (% of exports) trade' (% of exports)

1970-73' -2.22 5.67 12.5 12.7 25.2 36.0 8.2 -2.4 14.6 51.91 9.1 1974-78' 18.48 3.32 17.1 19.6 36.7 -45.0 -76.5 -133.6 -8.63 -53.25 10.7 1979-81' 7.61 10.10 15.3 20.0 35.3 -438.0 -426.8 -495.7 -42.92 -6.00 12.3 1982-84' -2.23 -17.63 20.8 20.0 40.8 160.7 15.5 256.2 16.11 -5.03 29.4

1985 3.25 -7.86 24.0 20.0 44.0 178.2 219.9 -120.2 20.88 -2.90 34.2 1986 27.43 39.59 23.1 18.3 41.5 273.3 319.9 67.2 25.12 13.50 24.7 1987 -3.90 19.33 19.9 18.2 38.1 102.4 141.9 -131.2 8.66 2.80 24.8 1988 5.69 -2.12 22.1 18.2 40.3 292.3 318.3 33.9 20.81 6.70 23.8 1989 6.18 -2.77 23.7 17.8 41.5 462.8 494.4 153.3 28.95 2.00 27.7

1985-89' 7.25 7.87 22.6 18.5 41.1 261.8 298.9 0.6 20.9 23.30 27.0 1985-87' 8.13 15.35 22.3 18.8 41.2 184.6 227.2 -61.4 18.2 13.29 27.9 1988-89' 5.94 -2.44 22.9 18.0 40.9 377.6 406.4 93.6 24.9 8.83 25.7 Table 5.2 continued

Price indices

Share of Annual variation Real Real wages wages Annual variations Annual variations Real exch. rate annual variations in GNP Years ICP INWP IPIG IPWAP IPWC IPWFP Dollar Exch. rate (1975=100) Public Private Total (%a)

1970-73' 49.64 53.74 51.15 60.69 67.58 51.06 36.41 0.31 95.16 -4.42 -3.65 -4.02 39.06 1974-78' 61.75 59.61 61.60 54.80 51.87 59.61 47.57 -0.56 98.40 -5.93 -5.14 -5.51 32.26 1979-81' 54.05 46.70 49.54 38.23 37.34 39.48 21.32 -7.84 78.86 1.71 3,06 2.43 27.26 1982-84' 40.22 51.46 49.78 57.03 61.26 50.92 73.10 13.21 105.43 -11.90 -8.83 -10.46 29.13

1985 72.22 76.57 84.05 53.90 50.10 60.17 80.73 0.44 112.15 14.07 14.89 14.13 30.54 1986 76.38 67.17 62.60 83.71 82.56 85.49 79.85 -7.05 104.24 4.85 7.99 6.75 31.40 1987 63.57 63.22 61.38 67.69 85.40 40.73 49.13 -4.00 100.07 0.49 7.94 4.68 31.52 1988 62.19 57.44 60.21 48.86 48.43 19.73 58.58 8.53 108.61 0.54 2.17 1.52 32.14 1989 80.45 73.18 72.92 74.06 70.36 81.39 68.46 10.49 120.00 -3.58 1.92 -0.38 32.86

1985-89' 70.81 67.38 68.09 65.15 66.63 62.57 60.92 1.45 109.01 3.10 6.88 5.22 31.69 1985-87' 70.64 68.90 69.19 67.99 71.91 61.10 59.25 -3.59 105.49 6.32 10.23 8.45 31.15

1988-89' 71.08 65.12 66.44 60.97 59.02 64.81 63.44 9.51 1 14.31 -1.54 2.04 0.56 32.50

Notes: 1. Annual averages. 2. Variations accumulated in the sub-period. ICP: index of consumer prices; INWP: index of national wholesale prices; IPIG: index of prices for imported goods; IPWAP: index of prices for wholesale agricultural products; IPWC: index of prices for wholesale cattle; IPWFP: index of prices for wholesale farm products.

Sources: Based on information from the Banco Central of Uruguay and the Direccion General de Estadistica y Censos. 146 Uruguay

Political openness succeeded in reestablishing dialogue and coexistence amongst the various social sectors. Negotiation and the search for consensus prevailed. The rules of the game imposed by the dictatorship were displaced. New conditions for the formulation of economic policy were developed. As a result of structural transformations during the 1970s, external shocks and the 1982-4 crisis, the functioning of the Uruguayan economy had undergone significant changes. These changes, added to the economy's greater international integration and a different economic policy orientation, had led to a new development pattern. As a consequence the general framework in which economic agents functioned had been modified substantially, as had the efficiency of the traditional instruments of economic policy. During the restoration phase some basic features must be emphasised. A crucial fact was the consolidation and legitimacy of political parties. After having lost their legitimacy during the 1970s, they managed to play a central role in society, showing the necessary flexibility and ability to absorb and neutralise social tensions, and to channel the complex political conflicts and the most extreme demands. The legitimate return of political parties to government was eased by the population's agreement to the fast recovery of public freedom and citizens', as well as social and political organisations' rights. This is understandable in Uruguayan society, where such values as freedom, safety, social peace, consensus, social conciliation, civil democracy and the welfare state are held in high esteem. The analysis of this period shows that several social groups curbed their disagreement, strengthened their democratic values and contributed to the consolidation of the new system by supporting the actions of political parties. This was expressed by their acceptance of the deterioration or lag in the income levels of several sectors. Various economic and social objectives were thus subordinated to the more general objective of assuring democratic restoration. On the other hand, the democratic transition accentuated the subor- dination of specific or sectoral policies to macroeconomic policy objectives: reduction of the fiscal deficit, price stabilisation and the balance of trade. As for institutions, the Ministry of Economy, the Central Bank and the Planning and Budget Bureau clearly prevailed over other ministries, particularly those of Agriculture and Industry. During redemocratisation the executive power dominated, while parliament played a secondary role in the design and discussion of economic policy strategies and guidelines. Luis Macadar 147

A decisive component of the long-term model was confirmed: external openness at both commercial and financial levels. Once the early 1980s crisis had been overcome, the tendency outlined during the dictatorship gained new force, stressing the exposure of domestic production to international competition. State intervention to sustain the solvency of the financial system was an explicit ratification of openness to international capital markets. The major goal of the new administration's programme was `sustained recovery through policies meant to lower inflation, reduce the public sector's deficit, and strengthen the balance of payments'.'` In compliance with this declaration, based on the traditional IMF diagnosis, short-run macroeconomic policy focused on the objective of price stabilisation. Therefore demand-controlling mechanisms (public expenditure, wages and domestic credit) were given priority in the actions of the state. An insufficient supply of goods was deemed to be the most important problem. Consequently, to relieve external constraints, emphasis was placed on the recovery of exportable supply. Considering that the monetary expansion required to finance the output recovery could jeop- ardise price stability or produce a serious imbalance in external accounts, an attempt was made to reduce the aggregate public sector's deficit. In this context, reduction of both the fiscal and quasi-fiscal deficit became the core of the programme, with targets having been established with regard to the expansion of domestic credit, reserves, monetary aggregates and so on in accordance with the usual standards set by the IMF in its stand-by agreements. The objectives of the programme signed with the IMF strayed from the CONAPRO (Concertacion Nacional Programatica) agreements in three areas.3 First, the objective of economic recovery was subordinated to price stabilisation. Second, exportable supply was given priority to lead the recovery, with the role of the domestic markets largely neglected. Third, a scheduled and selective recovery was not implemented. General instruments were applied instead, which did not dis- criminate between the different sectors. To achieve stabilisation, policymakers made use mainly of monetary and fiscal policies. Monetary policy regulated the different aggregates by increasing banks' required reserves, and by absorbing liquidity through interest-accruing monetary control bills placed with private banks. Fi- nancial market liberalisation was implemented with the removal of all ceilings to lending interest rates. Inflation would thus be slowed down, returning real interest rates to positive levels and increasing public 148 Uruguay demand for financial assets in domestic currency, which would then reduce the level of dollarisation. Fiscal policy stressed deficit reduction, having neglected public expenditure and income restructuring, despite the agreements of CONAPRO.4 Goals agreed with the IMF implied reducing the public sector aggregate deficit to 10.25 per cent of GDP by 1985, 6 per cent in the following year and below 5 per cent in 1987. These goals would be attained by tax increases, the creation of new taxes and more frequent adjustments to public sector prices. The exchange-rate policy called for a floating exchange-rate regime, with government interventions to offset fluctuations. The traumatic tablita experience ruled out any possibility of using exchange-rate policy as an instrument to fight inflation and risk further overvaluation. More- over such a policy could adversely affect the expansion of exports that was necessary to obtain trade balance surplus. Trade policy had been undergoing substantial changes since the mid- 1970s. Protection of domestic activities had been gradually reduced. First, non-tariff barriers to imports were eliminated (quotas, consign- ments, financing and so on) and an uninterrupted reduction of tariffs was instituted. From 1980 to 1982 the maximum tariff fell from 116 per cent to 75 per cent whereas the mean tariff fell from 49 per cent to 36 per cent. In January 1983 five tariff levels were set: a minimum 10 per cent tariff for raw materials not competing with domestic production; a maximum 55 per cent tariff for final-consumption manufactured goods; and three intermediate levels of 20 per cent, 35 per cent and 45 per cent for semifinished goods. By late 1989, after several reductions, import duties were fixed at a minimum of 10 per cent, a maximum of 40 per cent and three intermediate levels of 20 per cent, 30 per cent, and 35 per cent. During the first democratic administration, the maximum tariff dropped from 55 per cent to 40 per cent. Broad consensus existed about the need to recover real wages, which were deemed to play a considerable role in dynamising domestic demand. Notwithstanding this consensus, it was not reflected in the IMF stand-by arrangement, where a wage policy was proposed that would facilitate scheduled inflation slowdown without adversely affecting the employment level. It claimed that the only way to permanently increase real wages was by means of increased productivity and investment. During the dictatorship, private sector wages had been fixed administratively. After the reorganisation of trade unions, wage adjustments were processed at wages councils, a system of tripartite negotiation composed of entrepreneurs, workers and the government.' Wages councils Luis Macadar 149 first met in June 1985 and held meetings every four months. On some occasions, however, it was the executive power that set adjustments in order to drive price deindexation, impose some wage policy guidelines and smooth union conflicts. The mechanism adopted consisted of fixing a government guideline to adjust wages consistently with inflation goals, while fixing a ceiling for transfer of wage increases to prices. This implied controlling prices set by the private sector, while overseeing the amount to be transferred. During this five-year period, different criteria were used to fix the wage readjustment guideline: past inflation, forecast inflation, half-sum of past and projected inflation, and a percentage of past inflation. In the short run the economic policy aimed at making the demands from different social sectors compatible with the possibilities and resources offered by the evolution of the economy. To achieve this objective, in many cases government decisions moved away from official policy, since restoring democracy was of paramount importance. In summary, the economic policy tried to match the political objectives that all of the political parties and social sectors had accepted either explicitly or implicitly.

5.5 RECOVERY AND ADJUSTMENT

The economic process under the constitutional government can be divided into two distinct phases. The first one (1985-7) featured an economic recovery. During that time global growth (4.5 per cent annual average) compared favourably with Uruguayan historical levels and, above all, with the poor performance during the subsequent phase (1 per cent). This performance brought production back to 1980 levels (Table 5.1). The second phase (1988-9) was marked by the application of a domestic adjustment. Between the two stages, a set of measures were adopted in order to slow down the rhythm of economic growth. Output recovery did not follow a steady path, with different sectors leading each phase. Between 1985 and 1987 industry and the commercial sector expanded. In 1988 and 1989 the latter stagnated and industry slumped. The economy's performance during this phase depended on the agrarian sector and on a recovery in the construction industry. The sectoral profile was similar to the growth of exports during the 1970s, particularly because of the strengthened leadership of the manufacturing industry. The commercial sector also expanded, based on increased 150 Uruguay

foreign transactions due to the increased openness of the economy. The recovery of production occurred along with considerable restructuring of aggregate demand and supply. In the case of supply, the greater openness of the economy substantially enlarged the share of imports. As for demand, private consumption was the key component for output recovery over the first three years. In real terms consumption grew twice as quickly as exports. In contrast exports were the main growth factor during 1988-9 as private consumption tapered off. Aggregate demand was stimulated as a consequence of both the particular circumstances prevailing in Brazil (the Cruzado Plan) and improved terms of trade. This in turn invigorated domestic demand. The real wage increase during the first stage multiplied these favourable effects on domestic consumption. Moreover overvaluation of the currencies of the neighbouring countries greatly encouraged smuggling and exports to Brazil. The industrial growth profile shows that recovery was led by manufactures of semi-durable and durable consumer goods; by highly protected sectors; by production of manufactured goods costly in terms of domestic resources; by activities lacking promo- tional incentives; by highly import-intensive sectors; and by that half of industry with the lowest capacity to generate employment, either directly or indirectly (Noya, 1989). These findings confirm the disassociation between the system of incentives and the competitive structure of industry (Macadar, 1988). They also show that productive recovery was not a pattern of growth based on sectors with the greater comparative advantages, or in those sectors favoured by economic policy. Predominantly exporting sectors were also not the leaders of growth. Ultimately the recovery process can be seen as a restoration of activity levels lost during the crisis. Growth had a favourable impact on the employment level. Open unemployment fell to 8.7 per cent by late 1987, down from 13.7 per cent in early 1985. Despite output stagnation, by late 1989 unemployment reached its lowest rate (8 per cent) since 1980 (Table 5.1). Al- though there was no new employment generation during the second phase, the unemployment rate continued to fall until late 1989 as the working-age population decreased in Montevideo and additional jobs were created in the rest of the country. The investment level remained the most unsatisfactory component of economic performance. By mid-1987 trade balance projections showed a considerable deterioration, whereas the economy revealed a generalised excess demand in the goods market. It was realised that installed capacity had been used to the utmost. Since the recovery was the re- Luis Macadar 151 suit of higher capacity utilisation, continuity of growth was dependent on recovery of investment. However the investment coefficient only rose from 8 per cent of GDP in the first stage to 9 per cent in the second one (Table 5.1). These amounts were only half the average figure from 1973 to 1981. Therefore, by the late 1980s the economy was virtually stagnant as a consequence of negative net investment and almost full capacity utilisation. The poor investment performance was basically a response to the contraction in public investment. During the 1970s the military government had raised its share to an unprecedented 50 per cent of aggregate investment. Under the new administration, in contrast, this fell to one third. Since the government could not finance a large fiscal deficit through indebtedness, it strongly curtailed capital expenditure. Between 1985 and 1989 public investment was 20 per cent lower than during the 1982-4 crisis. The private sector became responsible for leading investment growth, while the government attempted to promote investment through different economic policy instruments. However the results show that these efforts were ineffective. Private investment during constitutional rule was 30 per cent lower than during the 1982-4 crisis. The rapid output and employment recovery gave rise to a sharp rise in imports. The unfavourable trade balance led to the different domestic adjustment measures adopted in late 1987: credit restrictions and interest and real exchange rate increases. The economy slowed down rapidly and stagnation set in again.

5.6 CONSOLIDATION OF EXTERNAL SECTOR LIBERALISATION

During democratic rule the rate of external sector liberalisation increased. In contrast with the 1970s and 1980s, increased external relations succeeded in obtaining favourable trade balances. Exports showed a growing trend in both value and volume. In real terms they increased 8 per cent per year during the first stage and almost 6 per cent during 1988-9 (Table 5.2). Output recovery also brought about a significant expansion of imports (15 per cent per year), which ceased by late 1987, thus fulfilling the objective of external adjustment. The role of the real exchange rate was relevant. Its level was defined by maintaining a stable parity with a basket of currencies where the US dollar had significant weight. The appreciation of European currencies in relation to the dollar in late 1985 improved significantly 152 Uruguay the competitiveness of Uruguay in those markets. On the other hand the stabilisation policy followed by Brazil resulted in relative prices that were extremely favourable for Uruguay, and Brazil became the major purchaser of Uruguayan exports (17 per cent of the total). In contrast trade with Argentina declined to levels significantly lower than those in 1979-82. Between 1985 and 1987 Uruguay benefited from the drop in international interest rates. Lower interest payments freed resources to finance the growth of imports, which was required to recover the level of economic activity. International reserves of more than $400 million were recovered, which partly offset the large loss of 1982 (Table 5.3). Dur- ing the 1980s considerable capital inflow (particularly from Argenti- na) had been attracted by large interest rate differentials, by the preannounced minidevaluation exchange rate policy, and by the climate of stability and safety offered to the foreign investor. The current account deficit could be thus financed without significant external indebtedness. Net external financing was very negative during democratic rule. While capital returned to the country in the first two years, during the last three, non-recorded outflows to finance smuggling and shopping in neighbouring countries reached considerable sums. Financial assets denominated in foreign currencies grew dynamically. Bonds and treasury bills issued to finance the public deficit rose from US$945 million in 1984 (more than 130 per cent of the deficit) to US$1800 million in 1989 (Table 5.3). In turn, non-residents' deposits grew from US$571 million in 1984 to US$1600 million in 1989. Uruguay's behavior was different from that of Argentina and Brazil with respect to external indebtedness. The latter countries financed their fiscal deficits by contracting domestic loans denominated in their respective currencies. The Uruguayan fiscal deficit, in contrast, was basically financed by contracting short-term liabilities in foreign currencies. This resulted in increased external indebtedness, to the extent that the gross external debt under democratic rule rose by 44 per cent in current values. By comparing this increased external indebtedness with such a poor investment performance, it is apparent that a substantial part of the increase in debt was destined to finance the fiscal deficit and interest payments. This development becomes even more risky in the long term, since this indebtedness (deposits and security issuance), coupled with the low share of long-term loans, has given rise to a highly fragile economic system. Luis Macadar 153

5.7 DOMESTIC DISEQUILIBRIA

The Fiscal Problem

The fiscal problem was focused on both foreign and domestic public debt service. Debt accumulation was twofold: -disequilibrium in government accounts and the government's assistance in sustaining an insolvent financial system (by purchasing matured portfolios and covering bankrupt banks' liabilities). Virtually all the public sector's consolidated disequilibrium derived from interest payments (5 per cent of GDP). During the first democratic quinquennium public sector management added a new source of rigidity to fiscal expenditure: conversion of the fiscal deficit into public debt. The indexation of this debt aggravated the problem of fiscal imbalance, since the growth of debt interest pushed up the growth of public expenditure and, as this could not be offset by revenue increases, the fiscal deficit. The public sector financial balance shows that the fiscal adjustment started by the dictatorship was continued during the 1982-4 recession. The consolidated public sector deficit was 8.9 per cent of GDP in 1984, down from 14.7 per cent in 1982, and kept falling until 1987, when it stood at 4.1 per cent. In 1988 it rose to 4.5 per cent and in 1989 to 6.2 per cent. Foreign-currency debt interest dropped strongly between 1985 and 1987, owing to both the fall in international rates and the depreciation of the dollar with respect to other currencies. However domestic-currency debt payments increased due to the expansion of monetary control bills held by banks. The second phase (1988-9) showed a completely different scenario. The policy of adjustment led to stagnation of the economy, while international interest rates rose. The immediate consequence was a drop in tax collection and increased expenditure. During 1988 and 1989 central government expenditure rose by 20 per cent in real terms, thus tripling its deficit in just two years. The public sector imbalance accounted for 6.2 per cent of GDP, resulting in one of the major problems inherited by the government that took office in March 1990.

An Unattainable Stability

Inflation rates, measured by percentage changes in the consumer price index (CPI), did not slow down during democratic rule. Inflation averaged 71 per cent per year, a record level for the past two decades Table 5.3 Uruguay: main financial indicators

Credit Private sector Bills Degree of MI M2 M3 index credit & bonds dollari- Year (Mill.N$) (Mill.N$) (Mill.N$) M1/GNP M2/GNP M3/GNP (1974=100) (% of GNP) (Mil.US$) sation

1970-73' 1974-78' 196.2 328.3 494.3 11.1 18.5 27.4 140.2 22.7 256.8 41.00 1979-81' 233.2 587.7 964.2 9.7 24.7 40.6 297.9 36.3 266.3 40.20 1982-84' 159.8 442.4 1236.4 8.3 23.1 64.5 433.3 65.5 686.0 60.90

1985 147.7 388.8 1129.5 8.3 21.8 63.3 332.8 54.1 1131.0 71.53 1986 155.7 381.2 1157.5 8.0 19.6 59.6 306.3 45.7 1284.0 71.38 1987 159.9 385.3 1226.9 7.2 17.5 55.6 316.0 41.5 1452.0 72.60 1988 154.5 381.4 1357.2 7.3 17.9 63.8 328.1 44.7 1714.0 76.40 1989 127.9 257.9 910.0 6.5 13.1 46.1 270.9 39.7 1797.0 81.70

1985-89' 149.2 358.9 1156.2 7.5 18.0 57.7 310.8 45.1 1475.6 74.72 1985-87' 154.5 385.1 1171.3 7.8 19.6 59.5 318.4 47.1 1289.0 71.83 1988-89' 141.2 319.7 1133.6 6.9 15.5 54.9 299.5 42.2 1755.5 79.05 Table 5.3 continued

Variat.' Net external financing Degree of Capital international Gross Net dollari- flows' reserves external Gross external Net capital Net Net sation (Mil. US$) (Mil. US$) debt reserves debt flows payments financing

1970-73' -44.7 -0.8 682.0 338.7 343.3 19.1 23.8 -4.7 1974-78' 41.00 16.3 -31.6 1136.1 892.1 244.1 165.1 66.2 98.9 1979-81' 40.20 -23.5 -89.2 2310.8 2784.6 -473.7 570.3 77.3 493.0 1982-84' 60.90 -541.2 208.1 4491.4 2065.3 2426.0 -27.1 282.1 -309.2

1985 71.53 239.2 64.8 4900.1 1989.0 350.9 -295.9 1986 71.38 200.4 -256.4 5238.7 2607.3 2631.4 192.1 278.0 -85.9 1987 72.60 -121.9 -44.5 5887.5 3099.7 2787.8 175.6 281.1 -105.5 1988 76.40 -227.3 -73.1 6330.5 3164.7 3165.8 39.2 305.7 -266.5 1989 81.70 -58.4 -94.0 6993.6 3749.0 3244.6 -58.6 349.1 -407.7

1985-89' 74.72 6.4 -80.6 5870.1 2921.9 2948.1 80.7 313.0 -232.3 1985-87' 71.83 105.9 -78.7 5342.1 2565.3 2776.8 140.9 303.3 -162.4 1988-89' 79.05 -142.9 -83.6 6662.1 3456.9 3205.2 -9.7 327.4 -337.1

Notes: 1. Annual averages. 2. (-) Flight. 3. (-) Increase.

Source: Based on information from the Banco Central of Uruguay. 156 Uruguay

(Table 5.2). Only two years (1987 and 1988) showed a different trend, but in 1989 prices rose by 80 per cent. The strong price instability may be considered a paradoxical outcome, since under the stand-by agreement signed with the IMF, reducing inflation was an unequivo- cal commitment. The conventional interpretation of inflation attributed an outstanding role to both the fiscal deficit and other monetary variables. How- ever, not only changes in monetary aggregates should be included. A more comprehensive interpretation would include the behaviour of a number of other variables such as public sector prices, interest rates, real wages, import prices, the real exchange rate and expectations. Greater increases in basic foodstuff prices, as compared with industrial prices, also pushed up inflation. The real exchange rate also increased by 20 per cent between 1985 and 1989. Consequently, the five-year democratic period ended up with the highest real exchange rate for two decades. Nominal wages, in turn, rose to almost 30 per cent above the CPI. The real lending rate was strongly positive in both domestic and foreign currency, which significantly affected firms' production costs. Public sector prices, on the other hand, rose along with other prices, remaining close to their real level. Uruguayan import prices grew steadily over the five-year period; in fact in 1989 they were 22 per cent higher than in 1986. The evolution of the real interest rate showed that agents' expectations were constantly changing as a consequence of the unstable price relations, which the economic policy of the democratic government failed to control. A persistent gap started to be noticed between the real borrowing (ex-ante) rate and ex-post returns based on effective inflation rates. This uncertainty caused agents to require higher interest rates before they would consider new deposits. Facts bore out this ex- pectation, with negative real returns by late 1989 for investments in both domestic and foreign currency. In early 1986, when ceilings on interest rates were eliminated, banking spreads were increased. Bankers sought to allow for possible capital losses given the financial constraints likely to be faced by firms. One consequence was the more than proportional rise of the lending rate compared with the borrowing rate. In domestic currency the spread was 12 points in 1984, rising to 40 in 1986 and dropping slightly during 1987 and 1988, but by the end of the five-year period it had reached 55 per cent. Its behaviour was similar in foreign currency. Changes in the real interest rate influenced the economy's degree of dollarisation. An ex-ante comparison of the real borrowing rate in Luis Macadar 157 domestic currency with that in foreign currency shows marked dis- parities in profitability between the different options. Dollarisation did not fall; in contrast it stood at 82 per cent by the period's end, up from 72 percent in 1985 (Table 5.3). This means that, in spite of the ex-ante rates differentials favouring investments in domestic currency, poor ex-post returns affected money demand, prompting a reduction of real balances as well as increased investment in foreign currencies. In the end, the five-year democratic period proved that economic policy was incapable of harmonising several objectives; that is, dedollarisation, investment, price stability and trade surplus. The focus on the external balance and financial liberalisation seems to have hampered both investment and dedollarisation. Over this period inflation was the consequence of the need to obtain financing to meet numerous objectives at the same time. In particular the foreign exchange required to meet both internal and external debt repayments, since money supply was limited, caused an increase in the real exchange rate, which in turn increased public indebtedness. The cost of reconciling all the different interest rates was inflation. Based on the above, it can be affirmed that price stability was not a real objective of economic policy. The reductions in inflation rates that did occur were not the outcome of a stabilisation policy, but of a temporary relaxation of distributive tensions. These tensions existed by virtue of the structural imbalances that characterise the Uruguayan economy. In the short run, to maintain these imbalances within certain limits provokes distributive tensions, which in turn result in permanent modifications to relative prices. These changes can generate inflationary expectations and, through indexation mechanisms, push up inflation. Favourable external shocks during the period helped temporarily to alleviate these tensions. Price increases were checked for a short time, but they resumed once the effects of these phenomena had been exhausted.

5.8 CHANGES IN INCOME AND FACTOR DISTRIBUTION

Under the military government, the share of wages and social security benefits in income distribution was dramatically reduced. However from March 1985 the income of these sectors began a steady improvement that lasted until late 1989, when once again there appeared unequivo- cal indicators of exhaustion in this redistribution process and the previous tendency resumed. 158 Uruguay

It is worth discussing which factors made this distribution improvement possible, and how it was relevant in consolidating democracy. In assessing these changes it is necessary to consider a number of new factors that started to influence the distributive process. During the dictatorship the state had been the only decision maker. The democratic rules of the game implied participation of economic agents and organisations in decisions related to price setting. Laws and other regulations on economy and society started to depend on the operation of the political system (institutions and political parties). Finally, in order for a party to remain in power, civil society had to be called upon from time to time to express its support through elections. These three basic features brought about important changes in the role of the state. In Uruguay the state was usually perceived as an entity whose operation was quite autonomous from economic groups, acting as an arbitrator in the struggle for distribution. The reinstitu- tionalisation that started in 1985 did not restore that role automati- cally. Authoritarianism had aggravated the state-society breakdown, and reaching basic consensus had been increasingly hindered. This was reflected in the growing difficulty faced by the democratic administration to define and implement an economic policy that could harmonise objectives and instruments, while at the same time reconciling the severe restrictions facing the economy with the interests of different social sectors. Managing the price and income policy, particularly the wage policy, together with the exchange rate and monetary policy in the framework of strong external restraints became the crux of this problem. As discussed above, democracy did not achieve any significant progress in matters of price stability. In the framework of higher than average inflation, relative price restructuring favoured the appropriation of income by the livestock sector, wage-earners and the public sector, while jeopardising industry's and real-estate owners' real income. Wages and social security benefits underwent an uninterrupted recovery during the five-year period, ending with the share they had had before the crisis (42.3 per cent). It is worth stressing that this large income transfer allowed wage-earners to recover income lost during the harsh 1983-4 recession. Between 1985 and 1989 this sector received a transfer of more than US$640 million, two thirds of which stemmed from an improvement in the terms of foreign trade, with the remaining 38 per cent deriving from transfers from productive sectors (Table 5.4). Dur- ing 1985-7 productive sectors and the rest of the world shared equally in the financing of wage-earners' increased incomes. Between 1988 and 1989 these transfers were almost totally covered by the improve- Luis Macadar 159

Table 5.4 Transfer of revenues (millions of 1984 dollars)

Productive Labour Rest of Year sectors force Imports Exports the world

1970-73 353 -67 -160 126 -286 1974-78 -218 -281 290 -209 499 1979-81 -92 236 -380 -236 -144 1982-84 162 -497 578 244 335 1985 -157 97 -49 -109 60 1986 -23 209 -256 -70 -186 1987 -33 113 -45 35 -80 1988 -10 78 76 144 -68 1989 -18 148 -14 116 -130 1985-89 -242 643 -286 115 -401 1985-87 -214 419 -349 -144 -205 1988-89 -28 224 63 259 -196

Sources: Based on information from the Banco Central of Uruguay and the Direccion General de Estadistica y Censos. ment in the terms of foreign trade. These findings confirm the hypothesis that the external sector's behaviour was crucial to the recovery of real wages. The fragility of this distribution pattern, which was solely dependent on favourable if ephemeral terms of trade, was tested during the beginning of the second democratic administration. In 1990 the reversal in external conditions changed this dynamic, and real wages and output deteriorated once again. In contrast with what had been expected, the political changes that propelled the return to democratic rule were not reflected by significant changes in income concentration. Available data - which is incomplete and statistically deficient - shows no significant progress in this respect. Income distribution continued to deteriorate in 1985 as the proportion of income appropriated by the upper decile continued to increase. While the concentration ratio dropped between 1985 and 1987, in 1988 it returned to its 1984 Level. Finally, although there was some degree of deconcentration, it was of limited scope, particularly considering the high wage and employment increases during the five-year period. On the other hand, the small improvement in income distribution and the higher real incomes of the poorest groups in society did not result in any significant loss for capitalists. The income of these groups was only adversely affected during the first year of democratic rule. 160 Uruguay

The implementation of the wage policy was the most significant change in the area of economic policy in the transition from dictatorship to democratic government. The change in the mechanisms of wage determination and further adjustments, jointly with other factors, resulted in a remarkable recovery of real wages, particularly over the first three years of democratic rule. In an overall review of the period, one notes that negotiations at the wages councils resulted in nominal wages evolving in line with inflation, plus almost 1 per cent on average in each negotiating round. These increases were significant, since they caused more than 70 per cent of the real wage increases resulting from negotiations at the councils (Frenkel and Damill, 1988). Another important factor was the inflation slow-down between 1985 and 1987. Before each pay round the government fixed the maximum amount of a wage award that could be transferred to consumers as higher prices. In spite of this mechanism, firms did not adjust wages strictly in accordance with what had been agreed. Factors relating to labour, unions and markets resulted in many firms paying more than had been agreed at the councils - more than 1 per cent in the quarterly pay rounds, accounting for a 17 per cent increase throughout the five-year period (Melgar and Hintermeister, 1989). Since entrepreneurs transferred all the wage increase to prices, they did not absorb the higher wage increases. Government guidelines were effectively applied to just few activities, whose prices were still fixed by administrative resolution (health, private education, transport and medicines). The CPI and wages developed asymmetrially during the democratic restoration period. The resulting income transfer favouring wage earners was estimated at US$ 2400 million, which enabled workers to recover one half of the purchasing power lost over the authoritarian period. This proves the favourable impact that this period had on workers' income, particularly during the first three years, when 85 per cent of the overall recovery took place. A simple comparison shows that income lost by the workers during the 1983-4 crisis was restored during the subsequent five years. Public social expenditure in Uruguay averages 14 per cent of GDP.' Expenditure on social security accounts for nearly half of this amount. Between 1985 and 1988 the latter's share of GDP rose from 11.2 per cent to 12.6 per cent because of the increased number of pensioners and a significant improvement in social security payments. To appreciate this improvement, it is worth recalling that GDP grew by 15 per cent over the same period. Education and health expenditure also increased at the beginning of Luis Macadar 161 the democratic restoration period. In real terms the increase was 70 per cent in education and 65 per cent in health. It is worth recalling, however, that the starting levels were extremely low. Despite this recovery, the levels reached lagged far behind historical norms. The share of education expenditure in GDP decreased by 50 per cent between 1973 and 1985. In absolute terms the education expenditure in 1986 was 7 per cent lower than in 1973 (Davrieux, 1989). Poverty in Montevideo was reduced considerably during the democratic restoration period. In the latter half of 1986 it was estimated that 15 per cent of households were living in absolute poverty, down from 25 per cent in the latter half of 1984 (Katzman, 1989). In spite of the return to democracy, a preliminary analysis reveals that poverty was not tackled head on. The principal measure adopted was an improvement in wages, with public social services playing a very secondary role.

5.9 SUMMARY AND CONCLUSIONS

If objectives, instruments and results attributable to state actions during the first democratic administration are considered as a whole, the general observation is that the number of objectives effectively pursued by policies lagged far behind those that were initially stated. There- fore, to distinguish this economic policy from that applied during dictatorship, it is necessary to disregard what was said and concentrate on what was actually done. In fact economic policy tried to harmonise demands from different social groups with the restricted resources it had available, and during a considerable part of the period it succeeded in doing so. Two factors provided economic policy with room to manoeuvre in order to achieve this harmonisation: output and productivity increases associated with production recovery, and increased income derived from the improvement in the terms of trade and from other favourable external shocks. Democratic transition became characterised by a recovery in the level of economic activity and by a noted improvement in wage earners' incomes. Each determinant operated mostly in one specific area of the process. Favourable external shocks were decisive in the recovery of economic activity. Economic policy, in contrast, played a central role in improving income distribution. External factors considerably enlarged the room to manoeuvre for economic policy, which had been greatly restrained by the crisis of 162 Uruguay the early 1980s as well as by the measures used to tackle it. Economic policy, however, did not play an important role in the recovery of production. Exchange rate policy was an exception, although it was not designed for recovery purposes. In 1985 a shift in the terms of trade favoured Uruguay for the rest of the period. The international interest rate also fell at the beginning of this period, easing the servicing of foreign debt. The effect of the increase in demand from neighbouring countries, particularly Brazil, was also of considerable importance. Another significant external effect was the fall of the dollar with respect to the stronger currencies. This effect alleviated the external indebtedness, and it relieved indebted firms, since exchange rate parity was maintained with respect to the weighted average of partners' currencies (Noya and Rama, 1988). All these phenomena, if significant in these circumstances, had only temporarily favourable effects. The above facts demonstrate the significant weight of external constraints on the functioning of the economy. In such cases the decisions taken are better explanations of economic policy than the objectives stated by political leaders. The struggle for the distribution of income which arose from these favourable impacts focused on three areas of macroeconomic policy: decisions on wage increases, choice and implementation of an exchange rate policy, and policies related to the operation of the financial system. Policies adopted in these three fields formed the core of government action since economic recovery depended mostly on them, whereas the demands emerging from different sectors were only partially dealt with. In the fiscal field the government appeared to have only a limited resolve to reduce the quasi-fiscal deficit. Neither did it appear willing to provide a solution to problems connected to weak portfolios and nationalised banks. The fact that control of the quasi-fiscal deficit was not a priority suggests that the interests of the financial sector prevailed over those of other sectors. In the productive field, the strategy basically consisted of encourag- ing exportable supply, the favourable trade balances of which were intended to service foreign debt repayments. Exports grew since firms were again profitable (given the favourable shocks), and this also meant that bank loans were repaid, relieving some of the pressure on the quasi-fiscal deficit. Paying foreign debt interest on time was an indication of good behaviour in the eyes of foreign creditors and international agencies. Credit Luis Macadar 163 was therefore made available to the government, facilitating its non- compliance with the goals agreed upon with the IMF. The goals set were not attained in any year, whether relating to inflation, the control of monetary aggregates, exchange rate flotation, fiscal deficit reduction, increases in public revenues, reduction of the quasi-fiscal deficit or public expenditure reduction. Positive external shocks favoured the articulation of the interests of different sectors. The new government's economic policy took advantage of these favourable conditions, and in the short run it managed to increase wages, recover output and employment, expand exports, ensure high income for exporters, obtain favourable trade balances, expand domestic industrial sales through higher wages, reduce the fiscal deficit, increase public-sector prices, reduce state firms' deficits, delay reimbursement of bank loans and ensure high returns to the banking system. However, since installed capacity was increased as quickly as the level of production was recovered, the ceiling for growth was reached and as a consequence policy makers had less room for managing income distribution. Moreover the favourable external shocks were somewhat reversed near the end of the first democratic administration. Finally, with productive recovery and income growth once again stag- nating, supply and demand could not be harmonised. The symptoms that had been faced by the new constitutional rulers in March 1985 surfaced again in a more aggravated form. The narrow room in which to manoeuvre economic policy deterred a solution to the difficulties arising from the incompatibility of the productive sector's expansion with the financial sector's development. A solution to this conflict was systematically avoided. Though attempts were made on several occasions, the problem of domestic indebtedness was not really solved. The fast and deep recovery of political freedom and rights in Uru- guay did not have a counterpart in the economic field. The period showed that the most outstanding features of long-run Uruguayan economic development remained the same; that is, the economy's difficulty to grow, low investment levels, virtual immobility of the productive structure, and an inability to design a new structure of comparative advantages and create productive employment (Macadar, 1989). A review of these problems would show that the progress made was practically nonexistent, the postponement of any serious solution being one of the costs of democratic restoration. The economic history record indicates that, faced with such a situation, the only way out for a government is to restrict expenditure at 164 Uruguay the cost, in particular, of deprived sectors of the population. Indeed there have recently been proposals to reduce the weight of the public sector in the economy by cutting its resource base. Different sectors approach the crisis by looking nostalgically at the past, exhibiting no creativity at all. These various interests demonstrate the difficulties prevailing in Uruguay of reaching a new consensus that could form the basis of a new project and a resurgence of the country.

Notes

1. Of 15 million hectares in agricultural use, 0.6 million are currently dedicated to crop production. Apart from a small area in the dairy sector, the remainder is left to extensive production of cattle and sheep in shared pastures. 2. This was according to the stand-by arrangement reached by the new administration with the International Monetary Fund (IMF) in September 1985. 3. CONAPRO was a group of civilian sectors formed by political parties' representatives, social organisations, workers' and students' unions, and business groups. It operated during two stages: first, before the Novem- ber 1984 elections it reached agreement on several issues (compensation to different social sectors, human rights violations, institutional rule recovery and so on). Second, after the elections it focused on economic policy issues, amnesty and education. In February 1985, some days before the installation of the new administration, CONAPRO approved an economic document containing basic guidelines for a concerted economic policy to be applied by the new democratic government, aiming to preserve institutional stability. 4. Public expenditure restructuring as agreed at CONAPRO implied growth in social expenditure (health, education and housing) to the detriment of defence and other unproductive expenditure. An explicit point was made on preserving public investment. On the other hand, it was pointed out that there was a need to increase gradually the weight of direct taxation and decrease indirect taxation, particularly value added tax. 5. The wages councils covered 48 sectors of the economy, subdivided into more than 200 groups. They determined wages for some 370 000 workers, including all private wage-earners employed in urban activities (Melgar and Hintermeister, 1989). 6. Consolidated central government expenditure includes central government and social security entities' expenditures. Local government expenditure is included therein, accounting for 8 per cent of overall government expenditure (Davrieux, 1989). Luis Macadar 165

References

Couriel, Alberto (1988) El Uruguay empobrecido: deuda externa y modelo neoliberal (Montevideo: EBO). Davrieux, Hugo (1989) Estudio analtico y prospectivo de la Republica Oriental del Uruguay: anexo XV: Gusto pdblico social y distribuci6n del ingreso (Montevideo: CINVE). Frenkel, Roberto and Mario Damill (1988) Concertaci6n politica de ingresos en Uruguay. 1985-1988 (Montevideo, Ministerio de Trabajo y Seguridad Social). Kaztman, Ruben (1989) `La heterogeneidad de la pobreza: una aproximaci6n bidimensional', in Uruguay, Direcci6n General de Estadistica y Censos, CEPAL, Pobreza y necesidades bksicas en el Uruguay: indicadores y resultados preliminares (Montevideo: Arca). Macadar, Luis (1987) Industrializaci6n, apertura externa y reestructura productiva: una resena del proceso de industrializaci6n en Uruguay durante los anos setenta (Montevideo: CINVE). Macadar, Luis (1988) `Protecci6n, ventajas comparadas y eficiencia industrial', Terceras Jornadas Anuales de Economia, Banco Central, Montevi- deo, 7-9 Nov. 1988. Macadar, Luis (1989) `Towards an analysis of the contemporary economic process', in Henry Finch, Contemporary Uruguay: problems and prospects, working paper no. 9 (Liverpool: Institute of Latin American Studies), pp. 71-88. Melgar, Alicia and Alberto Hintermeister (1989) `Los Consejos de Salarios en el sector industrial', paper presented at the Seminario La Industria Manufacturera, CINVE, Montevideo, 3-4 October 1989. Noya, Neson (1989) `El comportamiento reciente de la industria manufacturera en el Uruguay', paper presented at the Seminario La Industria Manu- facturera, CINVE, Montevideo, 3-4 October 1989. Noya, N. and M. Rama (1988) `La politica econ6mica en la transiti6n democratica: Uruguay (1982-1987)', mimeo (Montevideo: CINVE). Rama, Martin (1987) `Quien financi6 la reactivaci6n?: Cuando la dolariza- ci6n tiene sus ventajas', SUMA, Montevideo, CINVE, 2(3), pp. 105-20 (October). 6 Economic Policy and the Transition to Democracy in Paraguayl Melissa H. Birch

6.1 INTRODUCTION

Paraguay's transition to democracy began abruptly, and inauspiciously, with a military coup in February 1989, ending the 35-year rule of General Alfredo Stroessner. Like his predecessor, General Andres Rodriguez came to power by force, sought to validate his violent rise to power with hastily held presidential elections, and, after winning the elections, proceeded to rule with the support of the Colorado Party, one of two traditional political parties in Paraguay. Unlike his predecessor, however, General Rodriguez announced that he would not seek a second term of office and set a calendar for future elections, including those for delegates to a constitutional convention. The subsequent elections for municipal authorities (May 1991) and delegates for a constitutional convention (December 1991), and the enactment of a new constitution (April 1992) suggest a commitment to democratic processes. The dramatic increase in social activism, expressed both in public mass protests and in the plethora of new popular organisations, suggests a new tolerance for dissent and reveals a society in the process of revitalising itself in a democratic environment. Increasing civilian participation in government, including an opposition slate that won the Asuncion municipal elections and was allowed to take office, reinforced the new democratic image of Para- guay. Finally, in August 1993 - as a result of the presidential elections held in May - a civilian, Juan Carlos Wasmosy, took office. Though the elections were marred by some allegations of fraud, international observers argued the fraud was insufficient to change the outcome. Wasmosy is the first civilian to rule Paraguay in almost 40 years and his term will extend the Colorado Party's hold on the Para- guayan presidency past the half-century mark.

166 Melissa H. Birch 167

6.2 THE ECONOMIC LEGACY OF THE STROESSNER REGIME

The history of the Paraguayan economy during the Stroessner government can be divided into three distinct periods. The first, 1954-74, was one of economic adjustment and consolidation. The period of adjustment was brief (roughly 1954-7) and consolidation of economic achievements became the dominant theme of the period. The second period was characterised by the economic boom that took place between 1974 and 1981. The rapid economic growth of this period occurred as a result of the construction of the Itaipu Dam and increasing production of agricultural commodities during a period of high international prices. When construction ended and commodity prices dropped, the Paraguayan economy entered into a period of sharp contraction and stagnation that ran from 1981 until 1989. In terms of economic policy, the Stroessner regime will be perhaps best remembered for its emphasis on the development of Paraguay's physical infrastructure. The Stroessner government proved very astute at attracting foreign assistance for development projects by playing Paraguay's rival neighbours, Argentina and Brazil, against each other. Conspicuous displays of the government's anti-communist convictions in the days of the Cold War won it economic and military support from the United States. Aid from Argentina, Brazil and the United States paid for major infrastructure projects, including roads, schools, airports and dams.2 Economic growth was moderate during this first period and inflation was low. Average real growth hovered around 5 per cent in the 1960s, but in per capita terms this represented only about 2 per cent per year (Table 6.1). Paraguay ran a balance of trade deficit in four- teen of the twenty years, but foreign capital inflows were sufficient to cover the deficits in all but one year. In addition to official flows, the political and economic stability of this period attracted some private foreign investment. The stability also encouraged domestic investment and local industrial production. The combined effect of both public and private sectors was to double investment as a share of gross national product (GNP) from less than 10 per cent in 1957 to more than 20 per cent in 1974.' Population settlement patterns began to change significantly from the mid-1960s. A government programme established in the 1930s to relocate peasants to Paraguay's less populated eastern region accelerated its activities and informal migration increased, facilitated by the presence of roads into the area. At the same time Brazilian peasants, 168 Paraguay

Table 6.1 Real rates of economic growth

1961-70 1970-80 1980-90 1990-2

RGNP 4.6 8.7 3.1 1.9 GNP per capita 1.7 5.5 0.0 -0.9 Investment 9.2 18.2 1.2 0.8 Exports 0.6 10.1 6.6 -2.1 Imports 6.7 13.0 5.7 7.9

Source: Inter-American Development Bank (1990, 1993). forced off their land in that country's westward expansion, began moving into the border region and eventually to the Paraguayan side.4 An old border dispute that dated from the War of the Triple Alliance flared in the mid-1960s. The negotiations that followed led to the signing of the Itaipu Treaty between the governments of Brazil and Paraguay in 1973. The treaty created a binational entity that would undertake the construction and operation of the world's largest hydroelectric project, flooding the disputed boundary and providing ample electricity for both countries. Itaipu was clearly the final jewel in the Stroessner regime's infrastructure crown. At a time when many Latin American countries were accumulating substantial amounts of foreign debt to finance continued growth in the wake of the oil shocks, Paraguay's persistent current account deficit was financed by capital inflows for the Itaipu project. Compared with the size of the Paraguayan economy, these capital inflows were massive and financed a five-year spending spree from which the country has still to recover. Rising incomes derived from construction activities associated with the Itaipu project generated a second wave of spending. Demand for everything from wage goods to luxury imports increased. Land for small farms and large ranching and agribusiness operations was quickly taken all along the eastern border. Small homes for urban workers and mansions for the nouveau riche were built. Whole new towns sprang up in Paraguay's eastern region. This influx of cash also generated inflation and, as working-class salaries failed to keep pace (Table 6.2), an increasingly unequal distribution of income evolved. The failure of wages to rise during this period of increased economic activity can be explained as a function of both economic and political considerations. The Paraguayan economy in the 1970s closely approximated a classic labour-surplus economy. The increased demand Melissa H. Birch 169

Table 6.2 Changes in real wages

Year Wage index Year Wage index

1972 113.1 1981 105.3 1973 109.5 1982 102.4 1974 103.4 1983 95.1 1975 102.0 1984 91.8 1976 107.4 1985 89.8 1977 102.4 1986 85.9 1978 106.1 1987 96.5 1979 99.2 1988 103.9 1980 100.0 1989 109.8 1990 97.7

Source: World Bank (1992).

Table 6.3 Structure of Paraguayan economy (percentages)

1954 1960 1970 1975 1980 1988 1991

Agriculture 42 37 32 37 30 27 27 Industry 16 19 20 20 23 22 21 of which Construction 2 2 3 4 6 5 5 Manufacturing 14 16 17 16 17 16 16 Basic services 4 4 5 5 6 8 8 Commerce and finance 20 23 24 23 26 26 27 Other 17 18 19 15 15 17 16

Total 100 100 100 100 100 100 100

Source: World Bank (1992). for unskilled and low-skilled labour during the construction of the Itaipu Dam and its associated infrastructure was met by the return migration of young Paraguayan males from Argentina (and to a lesser extent Brazil) and the utilisation of previously underemployed workers from the agricultural sector. Many of the young men in this latter category expected to return to their place of origin and to buy farm land with their accumulated savings from employment in construction. Any upward pressure on wages that might have been felt was restrained by a government wage policy that limited collective bargaining and maintained a very low legal minimum wage. Thus total formal employment increased significantly during the 1970s without driving up wages. Between 1974 and 1981 the Paraguayan economy was the fastest 170 Paraguay growing in the hemisphere. It grew at an average annual real rate of 9.2 per cent, reaching a high of 12.8 per cent in 1977. Construction and agricultural exports drove the economic growth of the 1970s.5 The construction sector grew at annual rates of about 23 per cent between 1974 and 1981, increasing as a share of total economic activity from 3 per cent to 6 per cent (Table 6.3). Agricultural production was also strong during this period, which coincided with the international commodity boom of the late 1970s. Export revenues doubled between 1976 and 1979. Significantly, industrial production as a share of GDP stagnated. Almost inevitably, after the boom came the bust. Massive construction projects and export agriculture had been the twin engines of rapid economic growth in Paraguay in the 1970s. In their absence, economic growth stopped. According to government plans, another binational hydroelectric project, this time with Argentina, would pick up the slack as the Itaipu project wound down. Unfortunately, political changes in Argentina, disputes over financing and the letting of contracts, and charges of corruption delayed the project significantly. To complicate matters, floods and droughts in the early 1980s diminished agricultural production, and recessions in Argentina and Brazil (and sharp devaluations of their currencies) reduced the demand for Paraguayan exports. In 1982 and 1983 the economy contracted by 2.5 per cent and 3.7 per cent, respectively. A drought in 1986 halted growth again, but good weather for the rest of the decade facilitated agriculture and export- led growth. By this time, however, international commodity prices were no longer at their peak. Taken together, real economic growth averaged only 1.7 per cent annually for the 1982-8 period, and per capita income actually fell 1.5 per cent per year. The Stroessner government responded, quite typically, by trying to secure additional foreign aid for new projects. The international environment, however, had changed. Brazil and Argentina were suffer- ing from the effects of the debt crisis and were in no position to undertake new projects. The United States was only interested in anti-commu- nists in Central America and was considerably more critical of human rights abuses and the absence of democratic institutions in Paraguay than it had been in the past. Thus, in the early 1980s Paraguay made its first significant foray into commercial debt financing of infrastructure by accepting French aid to modernise and expand the national cement company and a Brazilian offer to debt-finance and build a national steel plant for Paraguay. From Japan came the finance for airports in Melissa H. Birch 171

Table 6.4 Paraguay: external debt

1970 1975 1980 1983 1988 1992 (est.) (a) Evolution of public external debt (millions of US dollars): Total 12 89 33 415 493 2291.0 Official - - - 708 1270 n/a Private - - - 437 821 n/a 1983 1985 1986 1987 1988 1992

(b) Selected debt ratios (percentages): Total debt/GNP 25 60 62 58 43 25 Debt service ratio 17 25 32 23 21 9 Consessional/total 27 24 23 22 22 n/a Interest arrears ($mn) 8 27 40 40 95 n/a

Sources: World Bank (1992); Inter-American Development Bank (1993). two border towns, Puerto Presidente Stroessner (now Ciudad del Este) and Pedro Juan Caballero. These projects were particularly ill-conceived, and they can be seen as the last gasps of a failing development model that hinged on foreign assistance and domestic patronage to guarantee economic growth and political stability. The public sector foreign debt nearly quadrupled between 1980 and 1988, from only $633 million to $2493 million (Ta- ble 6.4). Reflecting the pattern of infrastructure-led growth and the primacy of the public sector inherent in Stroessner's approach, much of the debt was official and concessional. Only in its last few years did the Stroessner government turn to short-term, commercial lending. By February 1989, Paraguay was $300 million in arrears on the foreign debt and had less than $200 million in reserves. Ex post, the government has claimed that in designing its policy response, it rejected shock measures that it felt would seriously and adversely affect certain social groups, particularly workers and farmers. Lack of political will to implement difficult policy reforms would be an alternative explanation for the absence of significant change in the economic environment. The experience of decades of rather effort-free economic growth, a stable rate of exchange and low levels of inflation seemed to have left government officials unprepared to take the bold steps needed to address Paraguay's increasingly urgent economic problems. 172 Paraguay

6.3 THE PARAGUAYAN ECONOMY IN TRANSITION

The constant refrain of the Stroessner years was `peace, jobs, and well- being'. By the late 1980s the latter two were in short supply and the February 1989 coup that brought General Rodriguez to power was a brief interruption of the first. The challenges facing the new government were great. The political system would have to be overhauled and the economy required both short-term stimulus and long-term structural reforms. Paraguayan economic policy, especially during the Itaipu boom, gave primacy to the rate of economic growth rather than the quality of economic development'! Without doubt the Paraguayan economy had experienced considerable economic growth. In fact during the Itaipu Boom it achieved some of the highest growth rates in the world. The record with respect to economic development is much less clear. The Paraguayan economy remains predominantly agricultural, with the primary sector accounting for more than one-quarter of GNP and half of all employment (Table 6.3). The country is basically self-sufficient in foodstuffs. Cotton and, beginning in the late 1970s with the Brazilian immigration, soybeans are now the principal exports and account for 60 per cent of all export revenues. Agricultural exports taken together account for 90 per cent of export revenues. Beef exports, which declined sharply when the European Community closed its borders to non-member imports, have increased in the last few years, mostly as a result of exports to Brazil. Paraguay's industrial sector is small and heavily dependent on agricultural inputs for processing. A 1984 United Nations Organization for Industrial Development (UNIDO) study found that 69 per cent of all industrial output was agriculturally based.9 Food processing alone accounts for 47.5 per cent of industrial production, which is primarily destined for the domestic market. Thus the economy is highly dependent on climatic conditions. Droughts and floods can significantly alter economic performance. If the share of industrial output in GNP is taken as an indicator of development, the greatest increase in `development' took place between 1954 and 1960. When construction is excluded, the share of industrial production was virtually stagnant during the entire 1954-88 period. Construction, which grew dramatically during the 1970s, has shrunk back to a more realistic level as the great infrastructure projects have come to an end. Low levels of public spending and the burden of debt repayment seem to preclude a return to construction-led growth, al- Melissa H. Birch 173 though spurts of private commercial construction may occasionally mitigate the impact on this sector. A sharp contraction in this sector implies an increase in unemployment unless alternative sources of employment can be created. Population growth has remained quite steady and high at 3 per cent. Until the 1980s there was always an expanding agricultural frontier. Those squeezed off the land, or left unemployed in the city, could move eastward and settle the vast extensions of state-owned land. But colonisation and sales (or gifts) to foreigners and political allies have exhausted the supply of state land in eastern Paraguay. Migration to the much less hospitable Chaco requires more capital than small farmers typically possess. Without an escape valve, rising unemployment will put additional pressure on Paraguay's limited system of social services and increase the urgency of a meaningful land reform. The Stroessner government's opportunistic approach to economic development, mostly responding to outside offers of project assistance, put little strain on domestic institutions. Since most projects carried a large component of grant, relatively small amounts of counterpart funding were required. These funds, along with those necessary to run a minimal government dedicated mostly to internal and external defence, could be raised from a large number of small, indirect taxes. As late as 1988, 84 per cent of all tax revenues were derived from indirect taxes. A personal income tax was proposed in the mid-1960s but was termed `communist' and its originator jailed. Until the 1980s public sector domestic borrowing was short-term and quite small. While more than half of central government spending was devoted to the military, the police and public works, only one quarter of the budget was spent on education and health. In Paraguay under Stroes- sner there was not much interest in providing education beyond the primary level. Secondary school curricula were carefully controlled. Universities and university students were regarded with suspicion. On the demand side, the economic return to higher education was low, since party membership and personal connections controlled access to the most desirable forms of employment. An active market served those who needed to show a thesis, exam score or diploma. As a result skilled labour and human resources are in short supply in Paraguay in the 1990s."' Thus by the end of the 1980s Paraguay was a predominantly agricultural economy, well-endowed with basic physical infrastructure. Suddenly burdened with a substantial increase in foreign debt, it was fortunate to have only a few white elephants. Yet despite years of 174 Paraguay economic growth and stability, there was a tremendous shortage of human capital and social services, and some basic structural reforms were long overdue.

6.4 ECONOMIC POLICY AND THE TRANSITION TO DEMOCRACY

General Andres Rodriguez was a businessman as well as a military man, and his presidency (1989-93) reflected that fact. Rodriguez appointed well-respected, experienced technocrats and businessmen to head the economic ministries and the central bank. From the beginning Rodriguez received strong support from the business community for the neoliberal economic policies he espoused, including free trade and a reduction of state intervention in the economy. Paraguay's finance minister said the government would `seek to implement a free market economic model for the country, with the minimum possible level of state intervention'.' Priorities for the government would include a programme of demonopolisation and privatisation, a major fiscal reform aimed at simplifying the tax structure and improving tax administration, an agro-industrial development programme, and incentives for foreign investment and service industries, especially tourism and banking. The new administration seemed prepared to combat inflation (running above 25 per cent in 1989) by reducing the budget deficit, tightening monetary policy and moving to reduce monopolies. Further heterodox or shock treatments did not seem imminent. Within weeks of taking office the new government eliminated the old system of multiple exchange rates and aforos,12 replacing them with a single, floating exchange rate system and a 1 per cent temporary tax on exports. International organisations such as the World Bank and the International Monetary Fund (IMF) had long been recommending this action but the previous government had resisted, fearing its inflationary impact. The Paraguayan business community had also been pressuring the government to return to a single exchange rate in order to eliminate the complexities that multiple rates introduced into international transactions and end implicit subsidies to certain activities. When the fixed rate had been abandoned hastily in 1986, the structure of the new multiple rates implied a significant subsidy to the public sector. This was done to enable the government to continue to service the foreign debt of the public sector without raising its guarani costs. As stories of government corruption circulated and government-owned Melissa H. Birch 175

public utility prices continued to rise despite the subsidy, the image of the public sector was increasingly tarnished and the willingness of the private sector to subsidise public sector debt waned considerably. A return to a single, market-based exchange rate was seen as a way of curbing government excess and stimulating private sector economic activity. After swift and decisive action with respect to foreign exchange, the expectations of the new government were heightened and Paraguayans eagerly awaited additional policy initiatives from the Rodriguez government; however they were slow in coming. Despite consistent rhetoric regarding a smaller state sector, the government was larger by most measures, not smaller, at the end of Rodriguez' term. Public enterprise operations had been rationalised and rates for most public services had seen considerable real increases, but none of the public enterprises had been privatised. The budget had been immediately brought into surplus in 1990 by reducing some capital expenditures, increasing public utility rates to bring prices more in line with costs, and increasing tax revenues by stepping up audits under a new single taxpayer registry and increasing some tax rates and fines. Over time some of these gains were eroded as current expenditures, especially for wages, climbed and public investment rebounded.13 A significant overhaul of the tax system was introduced in 1992. In design, the new tax system would improve efficiency, buoyancy and equity. In practice, difficulties at introduction and continued problems of administration resulted in lower revenues than expected and perhaps less equity than envisioned. While the Paraguayan fiscal system is much improved, the ratio of tax revenues to GNP is still among the lowest in Latin America and the budget continues to show a strong bias towards military, police and infrastructure spending (Table 6.5). The first Rodriguez budget was very disappointing in this respect. The Ministries of Defense and Interior accounted for 34 per cent of all public spending. If the budget for the Ministry of Public Works is added, the total rises to 54 per cent of the budget. In contrast education received only 17 per cent while health and agriculture each received 8 per cent of government spending. 14 If the Rodriguez government's priorities were indeed different from its predecessor's, the budget did not reflect the change and does not address the social demands that are finding expression in the democratic environment. Reforms in the financial sector were more significant and success- fu1.15 The government moved quickly to combat inflation by tightening credit and raising the reserve requirement and discount rate. In 1990 the government introduced a series of reforms that deregulated 176 Paraguay

Table 6.5 Central government expenditure by ministry

1989 1990 1985 1989 1990 (millions of guaranies) (per cent)

Defence 62 921 84 219 34 21 20 Public Works 67 010 82 781 6 22 20 Interior 36 070 56 393 14 12 14 Health 24 921 32 316 5 8 8 Education 56 512 70 272 16 19 17 Agriculture 22 781 32 007 2 8 8 Finance 10 646 23 470 6 4 6 Foreign Relations 11 789 21 377 3 4 5 Justice and Labour 4 879 7 415 - 2 2

Presidency 1 617 2 387 1 1 I

Industry and trade 1 668 1 955 1 1 1 Council of State 73 90 n/a - - Without portfolio 35 89 - - -

Total 300 922 414 771 100 100

Note: - is used to signify less than 1 per cent.

Sources: EIU Country Report, no.4 (1989); Banco Central del Paraguay.

interest rates, allowing them to rise to positive, free-market levels. In 1992 the central bank began open market operations. Various restrictions on bank lending that allocated credit to particular sectors were eliminated, earning the government praise from the international organisations and the wrath of adversely affected sectors, especially agriculture. The crisis in that sector in 1993 led to some back-sliding, as subsidised credit was made available to help offset the financial difficulties experienced with the failure of the cotton crop. A new investment code established in 1990 offered tax incentives to domestic and foreign investors, but provided no special treatment for particular categories of investment. High domestic interest rates seemed to attract an inflow of foreign capital. Democratic reforms, especially progress and promises in the area of worker rights, earned Paraguay renewed eligibility for participation in the United States' Generalized System of Preferences and loan guarantees from the Overseas Private Investment Corporation. After unifying foreign exchange rates the Rodriguez government sought to liberalise trade, significantly reducing trade taxes from an average of 14.8 per cent to 7.6 per cent, streamlining customs procedures and promoting regional integration with its participation in the Southern Melissa H. Birch 177

Table 6.6 Macroeconomic indicators, 1983-8

Average 1989 1990 1991 1992' 1993'

Percentage change: Real GDP 2.5 5.8 3.1 2.5 1.7 3.0 per capita 1.0 2.8 0.2 -0.4 -1.4 0.0 Inflation 22.6 26.2 38.2 24.3 15.1 25.0 Real wages 1.0 -1.2 -1.3 2.9 -3.3 n/a Government spending 1.9 13.5 2.8 3.1 4.9 n/a

Percentage of GDP: Investment 23.0 23.3 23.0 24.7 26.3 n/a Tax revenues 6.8 7.0 9.3 9.5 9.3 9.3 Govt expenditure 9.9 10.0 9.5 12.1 13.3 n/a

Notes: 1. Estimate. 2. Forecast

Sources: World Bank (1992); Banco Central del Paraguay; EIU (1993), nos

1 and 3: Paraguay.

Cone Common Market, MERCOSUR.16 While Paraguayans were initially very enthusiastic about MERCOSUR, closer scrutiny led business organisations to press for slower implementation of certain provisions and preferential status within the common market because of Para- guay's landlocked location. At the same time, Paraguay pressed the other members of MERCOSUR, especially Brazil and Argentina, for lower tariffs with the rest of the world and a speedier adoption of such tariffs. A study commissioned by the Paraguayan government showed that under a best-case scenario, MERCOSUR may result in a loss of 400 000 jobs in Paraguay. These losses arise from the demise of cross- border contraband trade (300 000 jobs) and the lack of competitiveness of Paraguays' small-scale manufacturing (100 000 jobs)." With regard to the foreign debt, the Rodriguez government suspended payments to all but the multilateral development banks in 1989 and asked for `patience' from all other creditors. The government immediately began negotiating with Brazil for relief on its debt with that country and slowly entered the secondary international debt market, buying back almost all of its commercial debt by 1992 at an average discount of 55 per cent." Negotiations with the Paris Club continued, but some bilateral lending resumed. The effect of the policies adopted by the Rodriguez government are 178 Paraguay hard to assess (for basic macroeconomic indicators, see Table 6.6). Climatic problems played havoc with agricultural output, the foundation of the Paraguayan economy. Droughts and floods reduced crop yields in 1991 and 1992. Coupled with lower international prices for cotton and soy, this resulted in lower export income. Unstable demand from Brazil and Argentina further aggravated the trade balance. Floods in the midwestern portion of the United States in 1993 brought higher international prices for the soy crop, improving the outlook for the agricultural sector and the economy as a whole for 1993. Attempts to tackle inflation by reining in credit proved difficult. Increasing levels of international reserves were a healthy sign for the economy, but they also increased the domestic money supply. The appreciation of the austral and cruzado relative to the guarani resulted in higher costs for imported goods, adding further to the inflationary pressures within the Paraguayan economy. This effect was mitigated somewhat with the devaluation of the real cruzado in 1992. The high inflation experienced in the first two years of the Rod- riguez administration was brought under control by 1992, but at the cost of economic growth. Inflation had increased from 17 per cent in 1988 to almost 40 per cent in 1990, but fell back to 17 per cent in 1992. However economic growth also fell, from 5.6 per cent in 1989 to 1.7 per cent in 1992. Expansionary fiscal policy financed by loans from the central bank in the year preceding the presidential elections resulted in higher growth (3.0 per cent) in 1993 but also a rise in inflation (to about 25 per cent). Within two years of taking office, there seemed to be general dissatisfaction with the new government's economic policies. Few decisive policy actions had been taken after the unification of exchange rates and the liberalisation of the financial sector. Inflation persisted, unemployment was high, and economic growth was declining. Despite the rhetoric, nothing had actually been privatised. In fact there seemed to be little change in public administration, except for the large and more frequent increases in the charges for public services such as water, electricity and telephones. In many ways, the economy seemed to be coasting. The excitement that accompanied the political changes introduced by Rodriguez was not matched in the economic arena. The explanation for the relatively slow pace of change in economic policy compared with advances in the area of political rights can be found in the lack of consensus both within the government and in society at large. While the Rodriguez cabinet was widely seen to reflect a more modern approach to economic policy, there were signifi- Melissa H. Birch 179 cant conflicts among the ministries. Campos identifies five separate currents of economic thinking within the government, ranging from the more traditional CEPAL structuralists to the Chicago-boy mon- etarism of Chile and Thatcher's free market Britain.19 The lack of a coherent government strategy for economic policy, coupled with poor economic data and very few well-trained specialists, prevented the new government from undertaking significant economic reforms. The private sector was also divided in its approach to economic policy and inconsistent in its advice to the government. While early supporters of Rodriguez' economic liberalisation plans, within six months of the coup the business community had begun to have second thoughts. The Union of Paraguayan Industries (UIP) protested that the government was moving `too far, too soon' on liberalisation. 21' The elimination of multiple exchange rates and the reduction of tariffs on goods from Argentina and Brazil from 30 per cent to 10 per cent resulted in increased competition from imports. Paraguayan firms argued they were unable to compete because of insufficient credit to modernise plant capacity and increase production. Rigidities in the banking system, including an extremely high reserve requirement, were blamed. The government's liberalisation of interest rates in 1990 also met with criticism. Despite its rhetorical support for a reduced role for the state and a move towards market forces, the response of the business sector to the liberalisation of financial markets was overwhelmingly negative. Representatives from the agro-business sector noted that It is impossible to understand how, when agriculture is subsidized all over the world because of its precarious and risky nature, here they decide to leave agriculture to its fate, allowing financing costs to rise to market rates'.21 FEPRINCO, an influential business association, acknowledged that the government's policy was in line with an overall shift to market mechanisms but suggested that other measures should be adopted to mitigate the effect on the agricultural sector.22 The government's first attempt at tax reform, presented to the public for discussion in October 1990, was so categorically rejected by all business sectors that it was withdrawn. These same groups had previously argued for a tax reform, but in the current context they resented the creation of new taxes and increased tax rates in the absence of sufficient attention to improved tax administration, a reduction in the size of the state and an end to corruption. The tax reform that was finally adopted in 1992 represented an improvement over the existing tax system, but fell short of the sweeping reforms originally envisioned due to the opposition of the business sector. 180 Paraguay

By the end of 1992 the relationship between the business sector and the Rodriguez government had deteriorated substantially. In an end- of-year speech the vice-president of the UIP openly attacked the government for corruption and presented the organisation's own policy recommendations, apparently unaware of the internal inconsistencies in its advice. It urged the government to liberalise financial and labour markets; reduce the size of the state through budget cuts, privatisation, and dramatic reductions in government employment; eliminate all deficits and subsidies; and save agriculture at any cost'.23 The business community was not the only group dissatisfied with the economic policies of the Rodriguez government. While a formal stand-by arrangement with the IMF was never concluded, the economic policy of the Rodriguez government often resembled an IMF stabilisation plan. Some social sectors complained that the economy was being subjected to IMF austerity without the IMF. They argued that the new government's policy was squeezing domestic consumption with tight monetary and fiscal policy in order to generate exports and an increase in reserves. Persistent unemployment, raised expectations of the new government, and the political opening that seemed to exist led to an increasing number of land occupations and demonstrations by landless peasants demanding land titles. Despite his democratic image, Rodriguez treated those `assaulting private property' in the same way as his predecessor had.24 Army and police units were dispatched to remove squatters, often violently. Various groups, including FEPRINCO and the Paraguayan Campesino Movement (Movimiento Campesino del Paraguay), have offered proposals for a major agrarian reform. While financing a significant reform may be difficult, political will appears to be the more serious obstacle. The conflicts in the agricultural arena reflect both the social and economic issues that confront Paraguay in the 1990s. In the past, agricultural output increased as land was cleared in the eastern border region and brought into agricultural production. Some of this activity was done by large agribusiness interests, both foreign and domestic. Other land was made available to peasant farmers through the government's agricultural colonisation programme run by the Instituto de Bienestar Rural (IBR). Initially this programme was relatively inex- pensive since the government had large holdings of vacant land in the eastern region of the country, however the supply of these tierrasfiscales has now been exhausted. Increasing agricultural production by extend- ing the land area dedicated to agriculture now implies increasingly Melissa H. Birch 181

Table 6.7 Real wages under democracy (percentage change)

1988 1989 1990 1991 1992 1993

Real wages 13.2 -1.2 -1.3 2.9 -1.8 -9.4 Minimum wage 18.0 -10.5 3.2 -10.6 -6.7 -13.9

Sources: Base ECTA Analisis del Mes (various issues); CEPAL (1993). rapid deforestation, bringing about the opposition of environmental groups and, to some extent, the World Bank and other international institutions that finance some of the government's endeavours in the agricultural sector. There are some alternatives, but they are expensive and/or politically unpopular.25 Rather than continuing to relocate peasants to the frontier, the IBR could buy land in the central region for colonisation or work with peasants in the minifundia region to introduce new crops and farm smaller parcels intensively. To do either of these things the IBR would probably need more funding than it currently receives. Alternatively, the IBR could invoke the government's right to expro- priate land when it is not being used `rationally'. Thus large landholdings left idle would be subject to expropriation. This would be less costly than both buying land at market value or investing in intensive agriculture, but it would not be politically popular. Many influential leaders in the Colorado Party (including both Rodriguez and Wasmosy, who are ranchers) are large landowners. They argue that expropriation would send the wrong signal to potential foreign investors and thus diminish Paraguay's chances for modernisation and growth. In the industrial sector, independent organised labour has also voiced its discontent with government policy. Unemployment remained high under the democratic government and, while the government did au- thorise increases in the minimum wage, real wages fell as the authorised increases failed to keep pace with inflation. Real wages fell almost 11 per cent between 1989 and mid-1993 (Table 6.7). Official stat- istics, however, do not fully reflect the erosion of real wages. Manda- tory wage increases were based on the government's estimates of inflation and only covered the minimum wage. Union estimates of inflation were much higher and enforcement of even the government-mandated increases was lax. Military salaries, however, doubled between No- vember 1988 and November 1990 and continued to rise. Indicative of the contrast between economic and political action, however, was the government's tolerance of union activity. Paraguayan 182 Paraguay labour law during the Stroessner regime (most recently codified in the mid-1960s) restricted union activity and, following a generally corporatist organisation, funnelled all authorised union activity through a government-controlled federation known as the CPT (Confederation Paraguaya de Trabajadores). Strikes were practically illegal, collective bargaining was minimal and enforcement of government-mandated wage and employment standards was lax. During the last five years, union membership, organising activities and the number of labour confederations have all increased. While the labour movement has been reinvigorated during the democratic transition, its effectiveness in terms of influencing economic policy has been minimal. Differences among the confederations have hampered its ability to win the passage of a new, progressive labour code.2R The fragmented nature of social and political organisations in Para- guay is perhaps best regarded as a function of both the long duration of the Stroessner regime and the newness of democratic activity. An important part of the legacy of the Stroessner political regime is the strength of the coalition he forged between the Colorado Party, the military and the state bureaucracy and the isolation of other social actors, virtually assuring their weakness in the political arena. The presidential elections of May 1993 brought to light some lingering behaviours that threaten the success of a meaningful democratic transition.27 The government's own party (the Colorado Party) is deeply divided between the arganistas, the militantes and the tradicionalistas. not to mention older divisions such as the MOPOCO. This division cane to a head during the party's process to select a presidential candidate for the 1993 elections. Juan Carlos Wasmosy, a businessman with no prior political experience and a Colorado Party member who had never held a party office, was hand-picked by President Rodriguez, much as in the tradition of Mexican politics, to be his successor. Apparently the strength of the arganistas - who declared their intention to bring Stroessner back to Paraguay from Brazil - was underestimated and Wasmosy's nomination by the party had to be engineered by Rodriguez. His willingness to intervene in the internal elections within the Colo- rado Party suggests that the democratic path was going to be well- marked by General Rodriguez and, by extension, the military. Until just before the elections, public opinion polls showed that opposition candidate Guillermo Caballero Vargas was in the lead. But in the final days before the election, high-ranking active military leaders made it clear that they preferred Wasmosy, now installed as the Colo- rado Party's standard-bearer. Perhaps the most inflamatory statement Melissa H. Birch 183 was made by Division General Lino Oviedo, widely regarded as the mastermind of the February 1989 coup that removed Stroessner from power. He said it was the decision of the armed forces to:

co-govern with the Colorado party por secula seculorum [sic] until the country achieves welfare and the common good, whether any- one likes it or not ... [Those] who attack and wish to denigrate the armed forces' by announcing that if elected they would reduce the number of general troops and trim the budget [should realize] that we.... will not stand by with our arms crossed (Riquelme, 1994, p. 54).

There were eight opposition candidates for the presidential elections. The two major opposition parties fielded starkly different candidates: Domingo Laino of the traditional opposition party, the Partido Liberal Radical Authentico (PLRA), and Guillermo Caballero Vargas for the Alianza Encuentro Nacional (AEN). Laino, as the leader of the opposition party during the Stroessner regime, had been jailed and exiled many times. Widely seen as a traditional caudillo politician, he was not a particularly attractive candidate to urban, middle-class voters. Caballero Vargas was a well-to-do businessman, a descendant of a founder of the Colorado Party but without a political past of his own. His party had come into existence after the stunning victory of an independent party, Asuncion Para Todos, in the 1991 municipal elections in Asuncion, and incorporated factions from a wide spectrum of political parties and social organisations. Because the AEN wished to attract disaffected Colorado Party voters, it was impossible for the AEN to enter into a coalition with the PLRA, the traditional rival of the Colorados. The May 1993 elections gave less than 40 per cent of the vote to the Colorado Party. An observer commented that the:

Colorados won with great difficulty despite being the incumbent party in power for over half a century and with all the state resources at their disposal. Despite the fact that the combined opposition forces of the PLRA and AEN, which totalled 55.27 percent of the vote, gave them an absolute majority of the vote, as opposition they lost. Nevertheless, the PLRA and the AEN garnered sufficient votes to control both houses of parliament and most departmental legislatures. Thus, the new president was inaugurated without a mandate and was 184 Paraguay

immediately forced to negotiate with the opposition to prevent a situation of ungovernability. This historical phenomenon may help to foster a desirable tempering of executive power in a country which has had a strong presidentialist tradition (Riquelme, 1994, p. 64).

The political life of the new congress should be rich in coalition and consensus building. As a result of the national elections, Argana controls 32 seats in the new Congress and has announced it will not vote with the Colorados but as a separate bloc. Most of the other factions of the Colorado Party are more conservative than Wasmosy and are thus unlikely to form coalitions with the opposition parties. The PLRA is divided into two factions. The faction led by Miguel Abdon Saguier is represented in Congress, but was blocked from taking a leadership position in the lower house by the Laino faction of its own party. The AEN seems badly bruised by its poor showing in the presidential elections and, lacking a strong ideology to unite the various members of the coalition, it is unclear how effective a force it will be in the new Congress.

6.5 THE UNFINISHED AGENDA: INSTITUTIONAL MODERNISATION AND ECONOMIC DEVELOPMENT

After twenty years of steady economic growth Paraguay experienced a sharp drop in per capita income in 1981, followed by nearly a decade of stagnation. For thirty years little attention had been paid to the structural reforms required to accompany a growing and modernising economy. During the last decade of the Stroessner regime a faltering political machine groped for short-term emergency measures to stave off economic disaster. As the 1990s began, Paraguay was in urgent need of fiscal, financial, judicial and agrarian reform. The Rodriguez government focused immediately on short-term stabilisation measures to reduce inflation and strengthen the country's external payments situation. The approach was a series of very conventional fiscal and monetary measures. In fact the first few years of the new government were not unlike the first few years of the Stroessner government (1954-7). By the end of his term Rodriguez, like Stroessner in the first two decades of his government, could claim economic stability and no arrears on external payments. Some progress on long-term structural reforms has also been made. Perhaps the most significant changes were effected in the financial Melissa H. Birch 185 system. Years of financial speculation and under-the-table deals had weakened the financial system, and corruption at high levels had led to inadequate supervision of the banking system. The tradition of sectoral credit allocations was open to abuse and distorted the process of financial intermediation. The absence of a capital market limited the instruments available to the Central Bank to control the money supply. As a result of the reforms the banking system is now more efficient and better regulated. It could provide a strong foundation for economic expansion. Reform on the fiscal side has been slower to emerge. For renewed long-term growth, tax administration must be improved and the tax base expanded. The budget, traditionally strong on defence and physical infrastructure, will now have to address long-postponed investments in social infrastructure. The development of human capital will be essential for both economic and political development. With MERCOSUR looming on the horizon, Paraguayan industry will need to invest to compete or be forced out of business. If the Paraguayan economy is to develop, and most especially if it intends to be integrated with world markets, the private sector will need an independent judiciary that will guarantee the enforcement of contracts. And finally, to elicit the required investment in agricultural modernisation, an economy heavily dependent on its agricultural sector for exports, employment and industrial inputs will have to redistribute a critical asset - land - in order to encourage its more productive use. The Rodriguez government has, however, permited much greater levels of activity for political and social movements than had its predecessor. In fact, after so many years of repression, Paraguayans were justifi- ably proud of the large number of different groups that sprung up to represent different points of view with regard to a wide range of social issues. Political parties flourished; women's groups were organised; environmentalists pressed for careful consideration of the environmental consequences of development plans; workers and campesinos organised in various ways to advance their demands. Not surprisingly, after so many years of repression, each of these groups was too small and organisationally inexperienced to exert much power. The high- profile role of the military just prior to the May 1993 elections suggests that there may be limits to the government's tolerance of independent political activity, and the resurgence of a military voice in the political arena may have a dampening effect on such activities. While differences in the political climate are salient in the post- Stroessner era, the immediate implications of the end of that regime 186 Paraguay for economic policy are much less clear. In the last few years of the Stroessner government Paraguay was under considerable pressure from international agencies to return to a market-driven exchange rate and to make changes in the financial system. It may have been only a matter of time before Stroessner would have had to succumb to the pressure, but it is also possible that the reforms undertaken would have been less far-reaching. Another thread of continuity in the area of economic policy is the vulnerability of the Paraguayan economy to the the changing economic conditions of its largest neighbours, Argentina and Brazil. In the 1990s this takes the form of MERCOSUR. The presidents of Argenti- na and Brazil made it very clear that Paraguay would not be eligible for membership in their integration plan until the country became truly democratic. The Stroessner government's declaration that it was democratic - elections were held every six years - were not accepted. But the election of Rodriguez in May 1989 and his declared commitment to democracy was sufficient to convince the MERCOSUR countries that Paraguay was now eligible. Thus the most important economic change for Paraguay in the absence of Stroessner may well be its membership in MERCOSUR. Member or not, the shift away from import-substitution policies in Argentina and Brazil and the movement of both those countries towards market liberalisation has dramatic implications for Paraguay. A significant portion of economic activity in Paraguay, and a very labour-intensive one, revolved around providing Argentine and Brazilian consumers with international manufactured goods they could not obtain in their home country. While many of these products came from third countries, some were produced in Paraguay. Textiles, clothing and leather products are the important elements of this latter category. The effects of a South- ern Cone common market on Paraguay will thus vary by industry and will depend on the exact form of the final MERCOSUR tariff structure." What is certain is that the existence of MERCOSUR will create significant restructuring of the Paraguayan economy. Paraguay is probably better off as a member of MERCOSUR than not, since membership will enhance its ability to influence the form and timing of these changes. Many changes in economic policy that would have been necessary to strengthen economic performance in Paraguay under almost any scenario (except total isolation) become more urgent, more widely recognised as important for economic performance, and perhaps also more controversial as a result of MERCOSUR. As a result of their survey of 65 Paraguayan firms, Fadlala and Masi identify three types of re- Melissa H. Birch 187 form that the changes brought about by MERCOSUR will require Par- aguay to undertake: agrarian, tax and educational.29 The process of attaining these and other fundamental changes in Paraguayan economic policy will be difficult. In the past, economic policy was ad hoc and driven by outside events. The Paraguayan economy lurched forward on the basis of fortuitous climatic and international circumstances. Those who wished to dissent could be repressed. In the democratic setting, the demands of various sectors should find expression in the Congress and be resolved into policy by debate and coalition building. While the Congress is currently dominated by the opposition, all the Paraguayan political parties are mired in divisive internal disputes and lack experience in developing independent policy initiatives. The Paraguayan transition to democracy seems to be well underway, at least insofar as political processes are concerned. Popular organisations representing numerous social groups have flourished and a new process of democratic elections seems to be taking root. Whether this new system will be able to deliver the economic policy necessary to meet the population's expectations is the challenge that faces the new civilian government.

Notes

1. An earlier version of this chapter was presented at the conference on The Transition to Democracy in Paraguay: Problems and Prospects' held at Notre Dame University in December 1990. This chapter has greatly benefited from the discussions held there. 2. For a fuller discussion of this pattern of behaviour, see Birch (1988) and Grow (1981). 3. Unless otherwise indicated, data are taken from the Inter-American De- velopment Bank (1990, 1993) or the World Bank (1992). 4. For an excellent analysis of this period see Nickson (1981). 5. Baer and Birch (1984). 6. Work on Yacyreta, a hydroelectric facility on the lower Parana River along the border between Paraguay and Argentina near the Paraguayan town of Encarnacion, was expected to begin in the early 1980s as construction activity at Itaipu was ending. The Yacyreta project is much smaller than Itaipu, but other hydroelectric projects along the Parana were also under consideration. 7. Latin American Regional Report - Southern Cone, 20 April 1989, p. 7 (hereafter cited as LARR-SC). 8. Herken Krauer (1986), p. 99. 188 Paraguay

9. As cited in EIU Country Profile 1990-91, p. 37. 10. Perhaps the only exception to this trend was in the field of engineering. Massive infrastructure projects did require engineers and usually some of them were Paraguayan. 11. ElU Country Report, no. 2 (1989), p. 18. 12. The aforo system was a complicated set of implicit taxes and subsidies embodied in the differential exchange rates and prices for specific exports and imports. 13. One provision of the new constitution requires that government pensions be brought in to line with current government salaries. The fiscal impact of this provision, if sustained, will be extraordinary. 14. For middle-income countries such as Paraguay, the world average for central government expenditure on defence is 13 per cent; on education, 13 per cent and on health, 4 per cent. While the share of the national budget devoted to education and health is not out of line with international averages, the absolute amount is small given the small size of the total budget and is inadequate to the demands of a democratic developing country. 15. Reform of the financial sector was directed solely at the formal financial markets. Access to and terms of credit for those operating in the informal sector were outside the scope of the government's attention. 16. Paraguay has also applied to become a member of GATT. 17. EIU Country Report: Uruguay, Paraguay (3rd quarter 1993), p. 25. 18. Inter-American Development Bank (1993), p. 149. 19. See Campos (1991), pp. 403-4 20. LARR-SC, 29 June 1989, p. 7. 21. Dr Francisco Solano Lopez, quoted in ABC, 20 October 1990. 22. Dr. Alirio Ugarte Diaz, president of FEPRINCO, as quoted in ABC, 20 October 1990, p. 9.

23. EIU, no. 1 (1993), p. 20. 24. President Andres Rodriguez, as quoted in LARR-SC, 31 May 1990, p. 7. 25. For a fuller discussion of the problems of land use, deforestation and agriculture, see World Bank (1992). 26. For details on the impact of the democratic transition on the labour movement in Paraguay, see Cespedes (1993). 27. For an excellent study of the 1993 elections, see the report of the Latin American Studies election observer team, Riquelme (1994). 28. A very detailed preliminary study of the implications of MERCOSUR for Paraguayan industry can be found in Fadlala and Masi (1991). 29. Fadlala and Masi (1991), p. 171.

References

Baer, Werner and Melissa H. Birch (1984) 'Expansion of the Economic Frontier: Paraguayan Growth in the 1970s', World Development, vol. 12, no. 8 (Au- gust), pp. 783-98. Baer, Werner and Melissa H. Birch (1987) The International Economic Re- Melissa H. Birch 189

lations of a Small Country', Economic Development and Cultural Change, vol. 35, no. 3 (April), pp. 601-27. Baer, Werner and Luis Breuer (1986) From Inward to Outward Oriented Growth: Paraguay in the 1980s', Journal of lnteramerican Studies and World Affairs, vol. 28, no. 3 (Fall), pp. 125-49. Base ECTA, Analysis del mes (Asuncion, Paraguay: various issues). Birch, Melissa H. (1985) `Public Enterprise and Economic Development: The Case of ANDE in Paraguay', unpublished doctoral dissertation (Ann Ar- bor: University Microfilms). Birch, Melissa H. (1988) `Politics de Pendulo: la diplomatica economica del Paraguay, 1940-75', Revista Paraguaya de Sociologia, vol. 25, no. 73 (September-December). Campos, Daniel (ed.) (1991) Desarrollo en el Paraguay: Contribuciones a una vision global (Asuncion: Centro de Information y Recursos para el Desarrollo). Canese, Ricardo (1980) Itaipu y la cuestion energetica en el Paraguay, biblioteca de Estudios Paraguayos, volume 7 (Asuncion). Centro Paraguayo de Estudios Sociologicos, Coyuntura Economica (Asuncion, Paraguay: various issues). Centro Paraguayo de Estudios Sociologicos (1984) Economia del Paraguay Contemporaneo (Asuncion). Centro Paraguayo de Estudios Sociologicos (1987) Economia Paraguaya 1986, 3 vol (Asuncion). Cespedes Ruffinelli, Roberto (1993). `Trade Unionism, Labour Law and Tran- sition in Paraguay', paper presented at the Society for Latin American Studies (SLAS), Manchester University, Manchester, UK, April. Cespedes Ruffinelli, Roberto (n.d.) `E1 sindicalismo en el Paraguay de la transition: reconstitution, escenarios, desafios', mimeo (Asuncion). Economic Commission on Latin American (ECLA/CEPAL) (1994) Balance Preliminar de la Economia de America y el Caribe (Santiago: CEPAL). Economist Intelligence Unit (1990) EIU Country Profile: Paraguay 1980-91, (London: EIU). Economist Intelligence Unit, ElU Country Report nos. 1-4, 1989; nos 1-3,

1990; nos 1 and 3, 1993 (London: EIU). Fadlala, Emilio and Fernando Masi (1991) Paraguay en el MERCOSUR: Empresarios ante la integration (Asuncion: IDIAL). Gamon, E. E. (1975) Itaipu: Aguas que valen Oro (Buenos Aires: Grafica Guadalupe). Grow, Michael (1981) The Good Neighbor Policy and Authoritarianism in Paraguay (Lawrence, KS: Regents Press). Herken Krauer, Pablo Alfredo (1986) via crucis economico 1982-86 (Asuncion: Editorial Arte Nuevo). Inter-American Development Bank (1990, 1993) Economic and Social Progress in Latin America (Washington, DC: IDB). Nickson, R. Andrew (1981) `Brazilian Colonization of the Eastern Border

Region of Paraguay', Journal of Latin American Studies, vol. 13, no. 1 (May), pp. 111-31. `Rechazo general provoco la liberation de tasas activas', ABC, 20 October 1990. 190 Paraguay

Riquelme, Marcial Antonio (1994) Negotiating Democratic Corridors in Par- aguay: The Report of the Latin American Studies Association Delegation to Observe the 1993 Paraguayan National Elections (Pittsburgh, PA: Latin American Studies Association). Sanders, Thomas G. (1989) The Fall of Stroessner: Continuity and Change in Paraguay', Universities Field Staff Reports, no. 2, 1989-90 (Indianapolis). World Bank (1992) Paraguay: Country Economic Memorandum (Washing- ton, DC: The World Bank). 7 Chile in Transition: Economic and Political

Strategies 1 Oscar Munoz Goma and Carmen Celedon

7.1 INTRODUCTION

The purpose of this chapter is to discuss Chile's experience during the transition to democracy from 1990 to 1992. The discussion will focus primarily on the economic policies implemented, the results of which support the premise that the Chilean economy is one of the most successful in recent history. The analysis would be incomplete, however, without also examining the political situation in Chile, which helped to make this economic performance possible. Section 7.2 focuses on the main options facing the country at the end of the military regime and the alternative proposals put forward at that time. Section 7.3 analyses the economic policy implemented by the Concertacion government from 1990 to 1992 and the principal results. Section 7.4 examines the role of the private sector, whose relationship with the Concertacion government proved to be decisive during the transition. Finally, section 7.5 addresses the most salient political and socio-economic issues that Chile's reemerging democracy will have to face during the remainder of the decade.

7.2 MAJOR STRATEGY OPTIONS FOR THE TRANSITION TO DEMOCRACY

In a plebescite held in October 1988, a majority of Chileans voted to end military rule. Presidential elections were then scheduled for the end of 1989 and the political campaigning began. For the next year the country debated the two principal strategy options for the 1990s. The first was proposed by Hernan Btichi and was essentially a continuation of the policies of the Pinochet regime. The second was presented

191 192 Chile by the Concertacion de Partidos por la Democracia (Coalition of the Parties for Democracy), a centre-left alliance headed by presidential candidate Patricio Aylwin. The country had waited seventeen years for a presidential election, the mechanism that best symbolises a presidential democracy. Apart from the specific contents of each side's platform, the two alternatives had profoundly diverging symbolic meanings: Biichi's proposals represented the consolidation of the ideas and transformations that had been carried out under the military regime. Moreover his candidacy implied not only a continuation of institutional stability, but also of the concentration of power in the hands of the elite and the state tech- nocracy. The candidate for the Concertacion, however, espoused political freedom from an oppressive and discriminatory regime. Although the Concertacion was fully aware of the institutional limitations, it proposed a strategy of progressive democratisation and national reconciliation for a country that had suffered from deep divisions and antagonisms. Finally, the Concertacion offered a way of reincorporating those social groups, political parties and ideas that had been persecuted and discriminated against during the military regime. Therefore, in order to ascertain the reasons for the Concertacion's triumph, not only must the political and economic contents of the coalition's platform be studied, but also the psychological and cultural environment of the country at the time. In spite of the differences, a comparative evaluation of the economic and social proposals of both platforms reveals convergence on a series of substantive issues. For example both candidates proposed that the current structural characteristics of the national economy be maintained: an open and internationally competitive economy; extensive use of the market and the private sector to lead growth; government responsibility for correcting social inequalities, for ensuring a policy framework with the explicit goal of macroeconomic stability and stimulating saving and investment (see Programa de Gobierno de la Concertacion de Partidos por la Democracia, 1989; Buchi, 1990). Differences mainly existed between their approaches to social policy and labour institutions. The Concertacion believed that economic adjustment had incurred extremely high social costs, which had to be corrected. It did not advocate a return to former populist practices, which continued to be employed in other Latin American countries, but rather the implementation of a very carefully designed social strategy that would be consistent with a macroeconomic equilibrium policy. Therefore social programmes and changes in labour legislation Oscar Munoz Gomk and Carmen Caled6n 193 would be framed within an economic policy that listed stability and growth as its first priorities. Yet at the same time that policy had to support the Concertacion's highest priority - a more equal income distribution. As a result policy makers argued that a tax increase was necessary to generate sufficient fiscal resources for new social programmes. To summarise, the Concertacion's economic policy diverged from that of the military regime in that it supported the following measures: (1) a tax reform to increase the amount of resources that could be devoted to social spending; (2) a labour legislation reform that would maintain flexibility in the labour market but recognise certain basic workers' rights that had been ignored under previous legislation; (3) halting the privatisation programme; and (4) regulating some natural monopolies or those economic activities that produce backward and forward linkages. In essence Bichi's programme proposed a continuation of the economic policies implemented during the second half of the 1980s. Dur- ing this period the Chilean economy, which had been seriously affected by the financial crisis of 1982, had experienced a dynamic recovery. The rate of GDP growth had risen from 5.7 per cent in 1987 to 7.4 per cent in 1988 and 10 per cent in 1989. The principle macroeconomic indicators had exhibited very positive results, in spite of a progressive inflationary pressure caused by an increase in the level of spending. This led Buchi and the current economic authorities to be optimistic about the development of the Chilean economy in the medium term, assuming that the present structural conditions and incentives for private investment were maintained. Furthermore they did not anticipate any problems stemming from the external sector. In fact in 1988-9 the balance of payments showed a positive balance, with a strong accumulation of international reserves, especially in 1988. This was the result of both a surplus in the current account and high net capital flows. An increase in the price of copper to record levels combined with strong growth in the volume of non-copper exports contributed to the current account surplus. According to Buchi, the foremost challenge was to improve social conditions. The modernisation of our economic and social system is incomplete. It must be deepened in order to improve the living conditions of Chileans, along with a social policy that presents equal opportunities and eliminates the economic restrictions on those who are not reaping the benefits of progress' (Democracia y Progreso, `Programa de gobierno de Hernan Buchi'). He argued that this would be achieved 194 Chile mainly through job growth (one million new jobs in the period 1990- 4) and through a social policy designed to provide all citizens with equal opportunities. Within this strategy, education would be the principal mechanism for social mobility. The foundation of Buchi's strategy was continued macroeconomic equilibrium and sustained economic growth, around 5 per cent per year, led by strong exports and private investment. The volume of exports was expected to reach US$12 billion in 1994. The state would subsidise the diversification of exports and an increase in their aggregate value. This rate of growth would generate the fiscal resources necessary to finance social programmes directed at those in extreme poverty. How- ever the growth would be stimulated by incentives to the private sector to increase private investment and by an increase in public saving. A decrease in taxes would provide the impetus for private investment. The tax reductions of 1988-9 and, to a greater extent, the promise of tax exemptions through Certificados de Credito Tributario (tax credit certificates) were aimed at spurring an increase in private investment. The subsequent decrease in fiscal revenues would be compensated by greater tax collection due to growth, as well as by a relative reduction in public spending. Furthermore the privatisation programme would complement the new tax policy. The other basic component of the growth policy was improved international competitiveness. The high real exchange rate reached in the previous years would be sustained in the medium term in order to promote exports. However the increase in liquidity had led to growth of the international reserves, which resulted in upward pressure on the peso as well as an increase in internal spending resulting from the monetarisation of those reserves. To combat these problems BO chi proposed reducing tariffs in order to lower the price of imports and absorb a portion of the increased spending, as well as increasing public saving, as mentioned above, to weaken the pressure on domestic spending. A greater flexibility of the capital account would complement the previous policies. One of the basic assumptions of the previous model, and in particular of the growth in international competitiveness combined with an increase in employment, was that real labour costs would not increase. Salaries would grow only in proportion to productivity. A change in labour legislation, as proposed by others, would increase labour costs and this contradicted the foundation of BU chi's model. Oscar Mun`oz Coma and Carmen Caledon 195

7.3 THE SOCIAL MARKET ECONOMY AND THE PRIVATE SECTOR

The ultimate justification for the Concertacion government rested on two elements: the recovery of democracy and the development of a social economy that would address the problem of unequal income distribution. However these presented serious challenges to the private sector. Political power was transferred to political parties that twenty years earlier had been considered the greatest enemies of the private sector because of their agrarian, industrial and financial reform programmes. The right-wing presidential candidate had exploited this situation, pre- dicting economic chaos should the Concertacion win the election. There- fore a major challenge for the Concertacion government was retaining the confidence of the private sector while simultaneously building an economy that would promote social equality.

Distributive Equity

One of the central objectives of the Concertacion's economic policy has been a more equitable distribution of income. The strong emphasis on macroeconomic equilibrium and growth was a necessary but insufficient condition for achieving equity. Therefore the government designed a social strategy based on the following measures: (I) tax reform; (2) labour reforms; and (3) income transfers (subsidies) and social policies.

Tax reform While the government was committed to achieving macroeconomic stability as a condition for sustainable growth in the medium tern, it also had to implement a public spending policy aimed at gradually reducing social debt among the poorest sectors. This social policy required an additional fiscal expenditure of around US$600 million, which was to be financed by an increase in taxes, thereby avoiding an increase in the deficit. The parties of the Concertacion had previously criticised cuts in government social expenditure. During the final years of the military regime, successive tax cuts had increased the deficit from 0.1 per cent of GDP in 1987 to 1.5 per cent in 1988, in spite of increases in the price of copper (Vial, Butelmann and Celedon, 1990). This was all part of the military regime's strategy to reduce the size of 196 Chile the state and transfer resources to the private sector. The Pinochet government was confident that economic growth alone would be sufficient to raise both employment and real salaries. The Concertacion, however, believed that economic growth was a necessary but insufficient condition to improve equality. Therefore taxes had to be raised by about 2 per cent of GDP, which in no way represented an intolerable burden on the private sector. Immediately upon assuming power, the economic authorities began to negotiate a tax reform package prepared by Concertacion technocrats. These negotiations were crucial because the government did not have a majority in the Senate (due to the appointment of `designated senators', written into the Constitution by the military government). These negotiations were also important to the Concertacion, whose political philosophy was based on the creation of broad national agreements to ensure stability. Therefore the tax reform, the first reform to be implemented, assumed a fundamentally political character because it would demonstrate the new spirit of cooperation between diverse political sectors. The idea was to develop a socioeconomic programme backed by the country as a whole, rather than having to impose one upon a minority. Such an achievement would ensure a broad commitment to both social policy and economic stability. The minister of finance personally entered into negotiations with Renovacion Nacional (The National Renovation Party), the main opposition party. The government proposal included (1) an increase in the corporate tax rate on total profits (not only those distributed to shareholders) from 10 per cent to between 15 per cent and 20 per cent; (2) the restructuring of progressive taxes for individuals, maintaining a maximum marginal rate of 50 per cent; and (3) incorporating certain productive sectors into the system of effective rather than estimated income. Reaction from the political opposition and business leaders was quite strong. Criticisms were not directed at the increase of funds for social purposes, but rather at the tax policy itself and were based on a range of ideological and practical arguments. From the ideological point of view, opponents argued that this reform would signal a return to statism, claiming that the state would regain its former size and responsibilities. Critics argued that, in order to generate the needed funds, the privatisation programme must be continued. In addition, greater fiscal austerity should be imposed; that is, low-priority government spending should be reduced. A second argument maintained that increasing taxes on the private sector would discourage private investment and growth. This would have a negative impact on a private Oscar Munoz Gomd and Carmen Caledon 197 sector already affected by the adjustment policy. Another position was to offer incentives for the reinvestment of profits. Others proposed the utilisation of resources from the Fondo de Estabilizacion del Cobre (Copper Stabilisation Fund) and an increase in value added tax. As a result of negotiations, during which modifications were made to the government's initial proposal, an agreement was reached with Renovacion National. The following measures were adopted: an increase in the corporate tax rate on total profits to 15 per cent for a period of four years; an increase in VAT from 16 per cent to 18 per cent; and the maintenance of taxes on estimated income for certain productive sectors (including agriculture). In return the government would ensure that the increase in revenues would be dedicated exclusively to social programmes.

Labour reform and the labour market The Aylwin government also proposed a reform in labour legislation to remove a series of institutional regulations that had fostered a weak labour movement and limited labour's ability to negotiate. Historically, labour organisations had been strong, but they had been severely weakened by the military regime. Legislation had been imposed that in effect prevented workers from negotiating contract conditions. If a more equal distribution of wealth were to be based on economic growth - that is, sustained improvements in jobs and real salaries - adequate mechanisms should exist to allow workers to negotiate with employers under equitable conditions. The labour reform of 1990 can be analysed from three different angles: general objectives, the negotiation process and contents of the reform. The general objectives were derived from the Concertacion's mani- festo and political philosophy. According to the minister of labour, the idea was to establish a system of labour relations (a `labour institutionality'), which would ensure long-term stability thanks to the voluntary adherence of major social actors, such as the private sector and labour organisations, as opposed to a stability imposed by the state. Under a democratic regime, dynamic economic growth requires institutional stability. This institutionality, however, cannot be upheld if business and labour perceive it to be unfair. Therefore, the government tried to obtain the backing of the major social actors for its labour reform. The second objective was concerned with the outline of the new legislation. The government wanted to reverse repressive labour legislation without returning to the previous confrontational, ideological and 198 Chile rigid model of labour relations. Neither continuity nor restoration was the motto of the new labour programme. The new legislation would favor direct negotiations between business and workers, avoiding government involvement except in cases where arbitration was necessary. The government planned to bring together major labour and business organisations, such as the Confederation de la Production y el Comercio (The Confederation of Production and Trade) and the Cen- tral Unitaria de Trabajadores (Workers Central), in order to reach a tripartite agreement on the contents of the reform. Although the representativeness of these organisations is questionable (in the case of workers, only 12 per cent were organised during the 1980s), they garnered considerable interest and were considered valid participants in the negotiation process. The government was successful in persuading these organisations to accept a framework agreement, but was unable to bring about a consensus on the specific contents of the reform. Therefore, the final version was left to political negotiation in Congress. Mutual compromises made by the private sector and labour were included in the framework agreement. Labour recognised ownership and private investment as legitimate bases of the Chilean economy, acknowledged the need for stability in the rules of the game and agreed to the removal of ideology from union negotiations. The private sector recognised labour's right to organise and negotiate, concurred that the benefits of growth should be distributed with equity and acknowledged the need to adjust the minimum salary, pensions and welfare benefits. Most importantly, the agreement demonstrated the willingness of both business and labour to negotiate. Both sectors had been willing to cede certain goals so that a basic agreement could be reached, within which more specific issues could later be negotiated. The framework agreement did not attempt to include specific reforms on labour union legislation, which would be negotiated separ- ately. In fact, it was impossible to reach voluntary agreements for these reforms, so the government negotiated the reforms at the political level. These reforms dealt with the following topics: justifications for contract termination, the right to strike, collective negotiation, and recognition of the rights of labour unions and federations. Under previous legislation companies could legally sack workers without providing a reason. Under the new legislation, although business retains the right to termi- nate employment, a reason must be given. Dismissal can be appealed against at a labour tribunal, whose findings may raise the cost of fir- ing. In the event that the dismissal is found to be wrongful, the em- ployer must pay additional compensation. Oscar Mun"oz Goma and Carmen Caledon 199

In addition, the government wanted to maintain the flexibility of the labour market, given the openness of the Chilean economy, and not return to the previous rigid system that had impeded the ability of firms to adjust quickly to loss of competitiveness and external shocks. In spite of the framework agreement and the positive outlook of key business leaders, 'these policies have been criticised by both the right and the private sector. Their main concern has been the effect that labour reform would have on future labour costs. Another criticism has focused on the supposed negative effects that an increase in the minimum wage would have on employment. This argument was based on the temporary increase in the unemployment rate during 1991. These critics argued that the real cause for this phenomenon was the rise in real wages, which limited the economy's ability to absorb additional growth in the labour force. However, the empirical evidence does not support this argument. The change in employment and wages depends to a greater extent on the conditions for economic growth than on labour costs. During 1991 and 1992 there was a significant increase in real wages. The average real wage during 1991 increased by about 5 per cent and a similar increase was predicted for 1992. Nonetheless, unemployment decreased from 6.3 per cent in 1989 to 4.5 per cent in 1992, with a temporary increase in 1991 due to the macroeconomic adjustment of 1990 (see Section 7.4). This is evidence of a constricted labour market. Despite the favourable effects that this has on distributive equity, the labour market situation could have unfavourable repercussions on international competitiveness. However, that would be the result of the effects of growth in the labour force, more than of the new labour institutionality. International competitiveness will depend on changes in productivity, which is becoming a key variable for sustaining the speed of growth, especially in tradable goods.

Income transfers and social policies The tax and labour reforms created the necessary framework to launch a more active social policy. This has been accomplished through a series of initiatives designed to transfer resources to the poorest sectors. Initial attempts were made to adjust the minimum wage, family allowances, family subsidies and pensions, as well as rescheduling mort- gages and basic services for these sectors. The minimum wage was increased by 44 per cent in 1990 and by another 27 per cent in 1991. Between the first six months of 1990 and the last six months of 1992 200 Chile it had grown by almost 24 per cent in real terms (Budnevich, 1992). Welfare benefits for low-income sectors increased by 100 per cent in 1990 and by an additional 24 per cent in 1991 (in nominal terms), or an increase of 61 per cent in real terms (Budnevich, 1992). These benefits, which were targeted at the poorest sectors, were complemented by new social policies, especially in the areas of social security, health, education and housing. First, the amount of fiscal resources allocated to these sectors increased considerably in relation to the amount they had been allotted at the end of the military regime. The following figures represent the increases in these funds for 1990 over and above the amounts budgeted for at the end of 1989: health 7 per cent, housing 39 per cent and education 23 per cent (Raczynski, 1992, and official data). With regard to social security, an effort was made to recover the real value of pensions, which had dropped precipi- tously in 1985 and had yet to be restored to their previous level. In addition to increasing resources, social policies have also sought to improve the quality and infrastructure of government activities and services. The most ambitious project currently underway is in education. Financed by the World Bank, this programme will evaluate the quality of education and the findings will be used to design new education policies. Other, more innovative, programmes seek to integrate the poorest sectors into society. One such programme is the Solidarity and Social Investment Fund (Fondo de Solidaridad e Inversion Social, or FOSIS), whose objective is to finance business endeavours among the poor and support microenterprises. The programme was inspired by the belief that the most effective strategy to eradicate poverty in the long run is to develop the productive capacity of those most affected by poverty. Projects are selected through a proposal review system designed to identify the most feasible projects in each of the areas- that meet the programme's requirements. A second programme is the Programa de Capacitacion Laboral de Jovenes (The Youth Training Programme), the goal of which is to train 100,000 unemployed youths between 1991 and 1994. This programme seeks the cooperation of the private sector.

The Reaction of the Private Sector

Relations between the government and the private sector developed in three phases. The initial phase was characterised by a lack of confidence and a sense of caution. In the second phase the private sector fully accepted the new government's policies and the transition to democ- Oscar Mun`oz Goma and Carmen Caled6n 201 racy. However the business sector was disappointed with the economic predictions for the first year, which had forced the government to apply adjustment policies and implement labour and tax reforms. In the third phase cooperation increased and the Concertaci6n authorities gained credibility in the eyes of the private sector. Certainly conflicts' cannot be avoided, but they have been largely confined to legislative and regulatory issues and have not seriously affected the private sector's overall evaluation of the government's performance.

First phase: overcoming distrust Under the Pinochet regime the private sector had recuperated prior losses. The authoritarian regime - its ideology and the reforms that it implemented - had awarded the private sector and the market the principal economic roles. Following the military regime's defeat in the 1988 plebescite, and as the last days of the Pinochet government drew near, old fears and distrust resurfaced. The private sector worried that the interventionist state would return. These fears were heightened as the weakness of the right and its parties became increasingly apparent. Not only had the right been defeated in the plebiscite, but more importantly, internal divisions and disputes remained unresolved. The greatest dilemma for the Chilean right has been whether to modernise and renovate its policy, in line with the transition to democracy, or to retain a conservative approach based more on personality and charisma than on specific political programmes. Given the prevailing situation, the private sector opted to distance itself from the Pinochet regime as well as from the political right and to focus on defending the free-market model, which had finally been embraced by a majority of large businesses (Rehren and Heredia, 1992; Montero, 1993). Predictions of a Concertaci6n triumph in the 1989 presidential elections led the Confederaci6n de la Producci6n y el Comercio, the largest business association in the country, to participate in working groups with Concertacion economists to debate new economic policies. The ideological evolution of the Concertaci6n also helped to improve relations. Before polls had indicated a Concertaci6n triumph and prior to positive economic signs, the Concertaci6n decided to soften its past criticism of the free-market model, to recognise the positive aspects of the current economic structure and, most of all, to recognise the importance of private property and business development. It was clear to the Concertaci6n economists that without a real commitment 202 Chile by the private sector to investment and development, it would be impossible to implement a successful economic policy. The private sector also knew that without some type of an agreement with the Concertacion there would be no guarantee that the current economic institutionality would be permanent. Therefore a common set of interests between the private sector and the future policy makers of the Concertacion government served to lessen distrust and generate an environment of cooperation between the state and the private sector (Rehren and Heredia, 1992). In fact investment programmes continued and there were no serious disturbances to economic activity.

Second phase: rapproachement and disappointment

By the time the Concertacion assumed power a general sense of confidence in the new political leaders had already been established. There- fore the private sector turned its attention to specific policies, focusing on tax reform, labour reform and macroeconomic adjustment policies. As mentioned above, the private sector reacted by criticising government proposals, but never by engaging in any type of destabilising behaviour. The private sector sought to defend the gains achieved during the military regime - that is, greater autonomy with respect to both the state and labour - that were being threatened by the labour and tax reforms. Successive tax cuts during the 1980s, social security reform and a reduction in relative fiscal spending had brought about the transfer of the greater part of national saving to the private sector. The plan to impose greater taxes on the private sector in order to finance increased fiscal spending appeared to be a return to statism. The labour reform that would return certain institutional guarantees to the workers was viewed in a similar manner. The private sector understood this reform to be an attempt to politicise contractual relations, which it felt should be strictly governed by the labour market. Two different views of the relationships between the state and the private sector, and between the private sector and labour existed. While among the private sector the prevailing view was one of conflicting interests, the government emphasised complementary interests. In essence, both the higher taxes and the new labour institutionality had contributed to social and political stability by legitimising the economic system in the eyes of labour and the poor. Moreover this social stability would benefit business in the long term. However the private sector, which focused on the short term, tended to emphasise corporate Oscar Munoz Goma and Carmen Caledon 203 resources as the catalyst for growth. As a result the failure of the business community to modernise its social relations has been criticised. This deficiency contrasts with the progress the private sector has demonstrated in other areas (Montero, 1990). However, the controversy surrounding the macroeconomic adjustment policy of 1990 revealed positions that contradicted these points of view. While the government and the Central Bank took a very cautious, even conservative approach to prevent a resurgence of inflation without drastically reducing the rate of growth (see Section 7.4), business proposed a decidedly more liberal and expansive policy, criticising the official policy as excessively restrictive. By not adopting expansive and generous policies to satisfy electoral expectations, the Concertaci6n had departed from traditional first-year government behaviour. The Concertaci6n government began by severely braking inflationary pressures to assure stability, even at the cost of sacrificing growth. A healthy expansionary policy, it was decided, could be implemented at a later date. Otherwise, according to the minister of finance, Chile would enter a regrettable populist cycle.

Third phase: optimism and expansion At the precise moment that the long-awaited adjustment began to materialise towards the end of 1990, and the GDP growth rate was reactivated, the private sector regained its optimism for the medium terra. Large investment projects continued and foreign investment increased in relation to previous years. The performance of the leading economic indicators, in particular the combination of accelerated growth, a strong increase in national saving and investment, and a decline in inflation and unemployment, restored private sector confidence in the economic policy and the economic authorities. Concern about tax and labour reforms has tapered off, but apprehension about the size of the state, considered excessive by the private sector, has remained. Criticism concerning the lack of privatisations has persisted, along with criticism of the level of public spending, which is mainly attributable to the deterioration of the real exchange rate during 1991-2. As discussed above, this is a complex subject that already had several factors in play. One of the principal factors was the strengthening of the Chilean economy, which generated a sustained surplus in the balance of payments and an upward pressure on the money supply following large capital inflows. However, other issues on the economic agenda have created important 204 Chile opportunities for cooperation between the state and the private sector. These include trade agreements with various countries, investment in infrastructure programme and new education programmes. The government has requested and received the backing of the private sector for many of its new policies on these issues. In early 1993 the Comision de Relaciones Economicas Internacionales (The Commission of Inter- national Economic Relations) was established, comprising both government economists and representatives from the private sector. This permanent commission acts as a consultant and will help design a unified trade policy.

7.4 MACROECONOMIC POLICY

Macroeconomic policy has been the central instrument of the Aylwin government in implementing its economic programme. Initially the medium term goal was to sustain an annual GDP growth rate of between 5 per cent and 6 per cent, combined with a gradual reduction in inflation. These measures would form the basis for equitable development, which would allow the redistribution of income to the poorest sectors of society. The export sector would continue as the catalyst for growth. Therefore it was essential that the real exchange rate be stabilised at the high levels attained in the previous years. The private sector would be the principal agent in the growth process and the formation of capital. Thus it was vital for the government to gain its trust and for good relations to be established. As the Aylwin administration completes its third year in office, its macroeconomic policy has been more than satisfactory. The economy has achieved an average annual GDP growth rate of around 6 per cent, with a strong acceleration that culminated in a rate of 10.4 per cent in 1992 (see Table 7.1). Initially, the administration had to face the serious problems caused by macroeconomic imbalance, which had been exacerbated by the excessive spending of the Pinochet government during its final year in power. The new government was confronted with a macroeconomic adjustment during its first three months in power (the second quarter of 1992) that led to a fall in the growth rate from 5.5 per cent in the previous quarter to 0.8 per cent. This adjustment continued throughout 1990, but by the beginning of the fourth quarter the economy began to grow faster. This acceleration continued in the following quarters, peaking at 13 per cent in the third quarter of 1992 and exceeding even the highest rates achieved during the previous Oscar Muhoz Goma and Carmen Caleddn 205 government. It should be noted that this performance occurred during the world-wide recession of 1991-2, when the global economy expanded at very low rates, rarely exceeding 1 per cent. Moreover, the vigorousness of the economy led to a drop in inflationary pressure from 27.3 per cent in 1990 to less than 13 per cent in 1992. Meanwhile, international reserves exceeded US$9 billion, equivalent to twelve months' worth of imports compared with six months' in 1981 and two months' in 1971 (see Foxley, 1992). According to the minister of finance, in 1992 the Chilean economy performed better than it had in thirty years, with an annual GDP growth rate of 10 per cent, inflation of 13 per cent, unemployment of 6 per cent (June), national savings of 19 per cent and a government surplus of 3 per cent (Foxley, 1992). This performance differs from the economic `boom' at the end of the 1970s when the expansion was based upon the growing use of foreign savings. During the 1990s, however, growth has been stimulated by an increase in investment and exports, with more moderate consumer spending, both public and private, and by a sustained reduction in the foreign debt as a percentage of GDP. Net foreign savings, as a percentage of GDP, fell from 2.2 per cent in 1989 to -0.8 per cent in 1991, which indicates a surge in domestic savings. Therefore, growth is solidly based on domestic resources and is stimulated by a cohesive economic policy.

The Adjustment Policy of 1990 and the Inflation Problem

When the Concertacion took office the economic authorities were faced with an imbalance in the macroeconomic equilibrium, a problem that required immediate attention. This imbalance was a consequence of the sharp increase in fiscal spending during the final years of the previous government. The economic authorities were certain that if spiraling inflationary pressures were not checked, there would be a serious risk of disequilibrium that would force the government to abandon its medium-term strategy. The Ministry of Finance emphatically expressed its interest in implementing an adjustment policy in the first quarter, and in relaunching the economy on a more solid path to growth at a later date. Considering the harsh impact that disequilibrium had had in other democratic transitions, maintaining macroeconomic equilibrium was the first priority during 1990. In 1989 domestic spending had increased by 12.7 per cent and imports were growing at an annual rate of 35 per 206 Chile

Table 7.1 Chile: evolution of the principal macroeconomic indicators

1988 1989 1990 1991 1992

Variations (%): GDP 7.4 10.0 2.1 6.0 10.4 Industrial production' 7.0 13.1 0.2 1.9 11.8 Unemployment 8.3 6.3 6.0 6.5 4.9 Inflation2 12.7 21.4 27.3 18.7 12.7 Relative price index (1988=100): Real Wages' 100.0 101.9 103.8 108.9 113.8 Real Exchange Rate4 100.0 97.7 101.3 95.7 88.0 Balance of payments (millions of US$): Exports 7052 8080 8310 8929 9986 Imports 4833 6502 7037 7353 9237 Trade balance 2219 1578 1273 1576 749 Current account balance -167 -740 -597 143 -583 Change in reserves 679 398 2409 1283 2369 Fiscal surplus/GDP (%) 0.9 1.8 0.8 1.6 2.3

Notes: 1. Index of industrial activity. 2. Consumer price index. 3. Wage index, deflated by the CPI. 4. Nominal exchange rate, deflated by the CPI.

Sources: Banco Central de Chile (1993), CIEPLAN (1993), Marfan and Vial (1995).

cent. Table 7.1 shows that inflation was accelerating at a dangerous rate, with the CPI rising from 12.7 per cent in 1988 to 21.4 per cent in 1989 and 24 per cent in March 1990, when the new government took office. Predictions concerning the external sector were caution- ary. Although by the end of the decade the external sector had ceased to be an effective obstacle to growth, due to the high price of copper and favourable debt renegotiations, these factors were not expected to last. Predictions called for a drop in the price of copper, an increase in amortisation payments resulting from debt negotiations conducted in the 1980s, and the repatriation of foreign capital under Chapter XIX of the foreign exchange law (Vial, Butelmann and Celedon, 1990). Faced with the inviability of using fiscal policy to correct the Oscar Mun`oz Gomk and Carmen Caledon 207 disequilibrium, because it had already been defined and legally sanc- tioned by the military government, the approach was to increase the interest rate. By the middle of the year interest rates had reached extraordinarily high levels, impacting directly on the growth rate. In fact, even before the Aylwin government assumed power the Central Bank, granted autonomy by the outgoing Pinochet government, had drastically increased interest rates from 6.8 per cent to 8.7 per cent on 90- day readjustable intruments (January 1990). The GDP growth rate braked sharply, falling from an annual average of 10 per cent in 1989 to 5.5 per cent in the first quarter of 1990, 0.8 per cent in the second quarter and 0.2 per cent in the third quarter (Central Bank, 1992). The average annual growth rate was 2.1 per cent, the lowest since 1985. Never- theless investment was satisfactorily high, approximating levels of 20 per cent of GDP, the highest rate of the decade. This was due in part to the long-term investment projects already underway. During 1990 the growth of exports continued at high rates - around 8 per cent annually, approaching a share of GDP greater than 30 per cent. The reactivation of growth strongly depended on inflationary tendencies, which already played a major role in determining the interest rates set by the Central Bank. Nonetheless, in spite of the decline in spending and the cooling of the economy resulting from the adjustment, inflationary pressures continued during the latter half of 1990, and the impatience of the private sector grew. Certain domestic and foreign factors contributed to the rise in inflation. Among these was the high degree of indexation of the Chilean economy (83 per cent of contracts signed in Chile have a six month indexation clause based on 100 per cent of the inflation for that period of time); the global increase in the price of fuel, spurred by the Gulf crisis; the prolonged period of drought and its impact on agricultural prices; and the effects of the tax reform implemented in July, which increased value added tax from 16 per cent to 18 per cent. All these factors contributed to rising inflation, which peaked at 30 per cent in October 1990. At this point it began to fall as a result of a number of factors: improved expectations in the external sector (the high price of copper was maintained and negotiations on Chile's foreign debt were successful); the end of uncertainty surrounding the price of oil and the prospects for the global economy brought about by the end of the Gulf War; the fall in interest rates during the final six months of 1990; and finally, the effects of a decline in domestic spending. In the last quarter of 1990, the economy was stimulated by lower interest rates and heightened expectations. This trend was reinforced in 1991, with a 208 Chile growth rate of 9.9 per cent in the final quarter and an average annual rate of 6 per cent. In spite of these improvements, macroeconomic equilibrium and possible imbalances remained a constant concern. In fact, in the third and fourth quarters of 1992 there was a strong acceleration of spending and growth, although this time it coincided with a sustained decline in inflationary tendencies. However fears lingered as to whether inflation in Chile was actually decreasing. It has been argued that the decline in inflation during 1991-2 was a decline in cost-push inflation, a response to such positive variables as the decrease in the price of oil, the fall in global inflation and, most importantly, an appreciation in the exchange rate (to be discussed below). In mid-1992 the real exchange rate was about 15 per cent lower than the 1990 average. In the final six months of 1992 there was a slight drop in the real value as a result of policies aimed at improving the exchange rate and eliminating disincentives for exports. However, even if it were possible to get rid of cost-push inflation, demand-pull inflation would remain, due to the fact that productive capacity would have been completely utilised. Even under the best of circumstances it would have been very difficult to continue lowering inflation from 12.7 per cent in 1992 to single-digit rates. Economic authorities, especially those at the Central Bank, expressed their concern about inflation. Some of the increases in interest rates during 1992 were clear indications that stable growth had reached its limit. The fiscal policy announced for 1993 was formulated around the assumption that there would be a more moderate increase in growth - around 5.5. per cent. In other words at the end of 1992 the Chilean economy was being driven by the private sector, which was investing more heavily and expanding its activity to uprecedented levels. Econ- omic policy has attempted to halt these stimulants in order to maintain a macroeconomic equilibrium that will assure stable growth in the long-run. Alternative analyses question whether spending really has been excessive, based on the fact that inflation continues to decline and international reserves continue to grow. If there has been excessive spending it should be reflected in either price increases or a foreign deficit. Therefore analysts argue that the Chilean economy has the capacity to grow at much higher rates than those projected for the medium term by the economic authorities. This growth would stimulate investment and eventual sectoral imbalances would be corrected by imports. But the evidence from the external sector shows that a trade deficit has Oscar Munoz Gomb and Carmen Caledon 209 been produced, the result of import growth of 26 per cent per year at the end of 1992, versus 12 per cent growth in exports (see Table 7.2.). Consequently, the trade surplus has fallen, generating a deterioration in the terms of exchange during the first months of 1993. The foreign exchange market has reflected these trends with a slight increase in the real exchange rate. The increase in international reserves can be best explained by the flow of capital, which has continued at high levels thanks to arbitrage operations resulting from differences between domestic and international interest rates.

The Foreign Exchange Market and its Monetary Impact

For the greater part of the 1980s the real restrictor of growth was the external sector. In the 1990s, however, this restriction no longer exists. The main problem in the external sector has been to identify ways of administering foreign exchange surpluses without generating monetary and exchange rate imbalances. Given that the Chilean economy is small and very open, monetary equilibrium is greatly influenced by events in the external sector. In general, strong growth in exports, incentives for foreign investment and the influx of capital, especially in the short term, contribute to an excess supply of foreign exchange and to a general trend towards currency appreciation, which negatively affects export oriented growth. In order to minimise this effect on currency prices and maintain them within the preestablished range, the Central Bank is forced to buy foreign exchange and increase international reserves. However, this produces monetary expansion and inflationary risks. Therefore, Central Banks must compensate by open market operations; that is sell foreign debt bonds. Such operations are limited by interest rates and conditions in the financial market. If the market is not able to absorb all of the available liquidity at current rates, Central Banks must increase their interest rates, which serves as a disincentive to investment. Thus a short-term conflict is produced between incentives for exports and investment. These conditions are typical of the recent situation in Chile, which is characterised by an overheated economy and excess spending. Some of the elements that are pushing the limits of spending must give way if a surge in inflation is to be averted. But the problem is complicated by the fact that the international context does not favour the control of domestic spending. In effect, an increase in Chilean interest rates while international rates remain low would attract short-term capital into the 210 Chile country especially from the United States, where rates have reached historically low levels. The economic authorities have employed various combinations of monetary and fiscal policies in carrying out their economic programme. During the first months of 1991 the Central Bank sought to control the influx of short-term capital by causing abrupt movements in the exchange rate, while maintaining the same overall trend in the exchange rate over the medium and long term. The purpose of these measures (previously unannounced slight revaluations or devaluations) was to provoke losses by short-term speculators. This policy was temporarily successful in restricting exchange rate operations. Given that Chile is seeking to expand the openness of its market economy, the problem called for a more in-depth set of policies. As international reserves were equal to ten months' imports, one possible route was to stimulate demand for imports in order to avoid a greater accumulation of reserves. It was for this reason that in June 1991 the minister of finance, in conjuction with the Central Bank, adopted a package of measures that included reducing tariffs from 15 per cent to 11 per cent in order to produce a shift in spending towards tradable goods; the decrease in fiscal revenues that resulted from the lower tariffs was compensated by an increase in certain taxes, such as the tax on petrol. The flow of short-term capital was stemmed through the establishment of 20 per cent obligatory reserves on external credits. Subsequently, interest rates were dropped by one half point in both November and December, following the reduction in the foreign interest rate on dollars.' To avoid excessive spending, the latter reduction was accompanied by a fiscal measure consisting of a prepayment of US$200 million by the Treasury to the Central Bank. These funds were generated by increased tax collection in 1991, resulting from economic activity that far exceeded that predicted. This measure was aimed, in part, at alleviating the difficult cash flow situation at the Central Bank, a legacy of the foreign debt crisis of the 1980s, when the Central Bank went into debt in order to subsidise and renegotiate the debt held by insolvent private Chilean banks. This situation limited the Central Bank's ability to conduct monetary policy, given that it had to balance its cash flow requirements with the need to regulate money markets through operations in the open market. Therefore, the prepayment by the Trea- sury provided the Central Bank with a greater flexibility to conduct monetary policy and signalled the commitment of the economic authorities to maintaining macroeconomic stability. Oscar Munoz Gomk and Carmen Caledon 211

Table 7.2 Chile: balance of payments, 1989-92 (millions of dollars)

1989 1990 1991 1992*

Current account: -767 -597 143 -721 Trade balance 1578 1273 1576 700 Exports 8080 8310 8929 10000 Copper 4021 3795 3617 3670 Non-copper exports 4059 4515 5312 6330 Imports FOB -6502 -7037 -7354 -9300 Non-financial services -634 -258 36 21 Financial services -1926 -1811 -1809 -1855 Transfers 215 199 340 413 Capital account: 1204 3292 934 3121 Medium- and long-term capital - 2107 1084 - Foreign investment - 1015 453 - Incoming - 1022 551 - Outgoing - -7 -98 - Credit expenditures - 887 458 - Other expenditures - 1328 1152 - Amortisation payments - -1171 -955 - Others - 48 -24 - Short-term capital - 1185 -150 - Commercial banks - 257 -283 - Others - 928 133 - Errors and omissions -326 161 0 Balance of payments 437 2368 1238 2400

* Estimate. Sources: Banco Central de Chile (1993).

The Foreign Debt

During the 1980s Chile accumulated a considerable foreign debt because of massive borrowing to finance growing spending, a policy that resulted from the 1982-3 crisis. Since 1985 Chile has steadily improved its ability to face external difficulties, as demonstrated by the decrease in the ratio of debt over GDP and debt over exports. Nonetheless, when the current government took office in March 1990 the country still had no access to voluntary credit and it was feared at the time that Chile would face a very constricted external situation, the product of mounting problems with the external sector and a worsening of its terms of exchange. Therefore Chile immediately sought to renegotiate its commercial foreign debt and succeeded in substantially 212 Chile easing its foreign accounts. The agreement reached in 1990 postponed amortisation payments on commercial debt from 1991-4, with payment to resume in 1995. The agreement also allowed interest to be paid anually instead of every six months. As a result of these negotiations with the principal international financial institutions Chile regained access to voluntary credit markets, through which the government issued bonds totalling US$320 million over a two-year period. The first US$200 million was raised in 1991 with the issuing of the first international bonds by the Chilean government. The decrease in public foreign debt during 1991-2 was basically the result of the public sector policy, which stipulated that excess resources be allocated to the amortisation of the foreign debt (see Table 7.3). The private sector, however, has increased its level of debt by expanding investment, particularly in minerals, cellulose and energy.

7.5 DEMOCRACY AND GOVERNABILITY: THEMES FOR THE 1990S

If the economic policy of the Aylwin government has been successful. maintaining a high rate of growth, stability and fostering greater social justice, the government has been just as successful in the political arena, considering the enormous difficulties it faced initially. The military regime did not believe it would be defeated in the 1988 plebiscite, assuming that it would continue to hold power throughout the 1990s, thus allowing consolidation of the authoritarian political institutions it had imposed. General Pinochet's decision to remain as commander-in- chief of the armed services was a clear sign of his determination that this institutional ity be retained. Therefore when Patricio Aylwin assumed the presidency certain restrictions had been placed upon his power. However Aylwin intended to make full use of the tremendous powers granted to the president by the Constitution, as demonstrated during the period just prior to the inauguration of his government and, in particular, during the discussion between advisors to both sides over legislation pertaining to the armed forces (Cavallo, 1992). The Aylwin government was not a fully democratic government, but rather a transitional one whose role was to move the country towards full democracy in a stable manner. The new government was fully aware of the great risks it faced. On the one hand it had to take care not to offend the armed forces, and on the other it had to satisfy public demands for democratisation. Oscar Munoz Goma and Carmen Caledon 213

Table 7.3 Chile: foreign debt by debtor at the end of the year and indebtedness indicators (millions of dollars)

1985 1989 1990 1991 1992'

Medium- and long-term 17650 13279 14043 14217 14401 Public sector 12215 10350 9808 9490 9092 Private sector 5435 2929 4235 4727 5309 Short-term 1794 2973 3382 2199 3389 Public sector 1564 1901 1984 1064 314 Private sector 230 1072 1398 1135 3075 Total foreign debt 19444 16252 17425 16416 17790 Public sector 14079 12251 11792 10554 9406 Private sector 5365 4001 5633 5862 8384 Central bank with the IMF 1085 1268 1151 955 741 Total reserves 1867 2948 5357 6640 8716 Discounted debt titles (%) 33.0 40.2 32.4 16.02 10.0 Foreign debt indicators: Total debt over GDP (%) 116.0 69.0 66.8 55.5 49.4' Total debt over exports 5.4 2.2 2.2 1.9 1.9 Debt less international reserves over exports 4.7 1.6 1.5 1.1 0.9 Interest over GDP (%) 11.5 7.0 6.6 6.7 n. a. Interest over exports (%) 41.1 22.0 22.0 19.22 n.a.

Notes: 1. 1992 figures to October. 2. September 1991 observation. 3. Estimate to November 1992.

Sources: Central Bank of Chile, Informe Econ6mico y Financiero (1992); Devlin and Ffrench-Davis (1995).

Several other relevant issues surfaced during the transition period: the act of balancing political reforms and institutional stability; the configuration of political parties and alliances that made governing difficult; and new socio-economic issues.

Institutional Equilibrium During the Democratic Transition

The Aylwin government had initially been defined as a transitional government. The military regime had been defeated politically, first in the 1988 plebiscite and then in the presidential elections of 1989. This defeat had come about within the rules defined by the military regime itself in the 1980 Constitution. The parties of the Concertacion decided 214 Chile to abide by these rules when it became apparent that social mobilisa- tion, starting with the protests of 1983, would not force the resignation of Pinochet. The defeat of the military regime through political mechanisms served to legitimise the Constitution and therefore the reemerging democracy was forced to function within constitutional constraints. The principal institutional limitations were the following: `designated' senators (not elected), which precluded a Concertacidn majority in the Senate; the electoral system; the `unremovability' of the commanders in chief of the armed forces; the composition and characteristics of the Constitutional tribunal; and the National Security Council. In order to remove these limitations, which restricted the expression of popular demands, political reforms would have to be implemented. However doing so would not be easy because the government did not hold a majority position in the Senate. Therefore the government had to reach an agreement with opposition parties. Thus negotiation with other parties was a central theme of the transition. Another important theme was reparations of human rights violations. This was one of the most difficult issues for the government because the demand for justice requires, among other things, the punishment of those responsible, even officials of the armed forces. The experiences of neighbouring countries such as Argentina and Uruguay alerted Aylwin to the difficulties this would pose. In both instances the goal of punishing those responsible endangered democracy by provoking a return to barracks and military rebellions that concluded with the civilian government granting a general amnesty and calling for an end to investigations. The Chilean government followed a different strategy (Zalaquett, 1991). It was based on the assumption that reparation consisted of various elements: knowledge of the truth; moral reparation - that is, those who were unjustly accused should regain a sense of honour and dignity; material reparation, wherever possible; and punishment of those found guilty of human rights violations. The goal was to maximise each of the four elements, while at the same time avoiding a reaction from the armed forces. A commission of public figures was formed to determine the facts surrounding the human rights cases and to establish the identities of the victims without naming the perpetrators. This responsibility belonged to the judicial branch and was not challenged by the government. The victims themselves or their families would have to initiate proceedings. The information provided by the Comisidn Verdad y Justicia (Truth and Reconciliation Commission) had an enormous Oscar Munoz Gomk and Carmen Caleddn 215 impact on public opinion, and the president, on behalf of the Chilean state, publicly requested the country's forgiveness. Two branches of the armed forces, and army and the navy, rejected the findings and denied institutional responsibility, arguing that these events had taken place during a state of war. The Supreme Court also rejected the report. But a majority of political institutions, the Catholic Church, the air force and the carabineros (the police force) accepted the validity of the report. Some organisations of the families of political prisoners and the disappeared opposed the government's strategy when it became apparent that the government would not be a party to the law suits. The national debate surrounding the Truth and Reconciliation Re- port ended abruptly following the assassination of a prominent opposition senator, Jaime Guzman Errazuriz. During the 1960s he was a well-known student leader of the new right, the intellectual power- house behind the institutionality imposed by the Pinochet regime, founder of one of the two right-wing parties and elected senator in the parliamentary elections of 1989. His assassination, by an extreme left-wing terrorist group, altered the terms of the political debate. Terrorism had become a reality and the ability of a democratic system to contain it was brought into question. The right's position hardened, which forced a change in the government's strategy for dealing with the armed forces, which had previously been to diminish their political profile and subordinate them to the executive branch. Faced with intensified right-wing opposition combined with a minority status in the Senate, the Concertacidn government opted to reevaluate its political priorities. In the area of institutional reforms the government decided to concentrate on municipal and regional reforms and postpone all others. Less controversial public policies were emphasised, such as pollution control, improvement in infrastructure and the strengthening of the police force's technical capacity to fight crime and terrorism. This strategy had various consequences for the government. First, it neutralised the risk of alienating the armed forces and thus reduced the possibility of being threatened by them, which has been the government's principal goal throughout the transition. The public, however, viewed it as a loss of political power. Nevertheless the government continued to enjoy a majority level of support during a time of political apathy and growing disinterest in public issues, especially among the young (Bano, 1991). 216 Chile

Political Parties

Patricio Aylwin won the presidential elections with approximately 56 per cent of the vote. During his first year in office his popularity increased considerably and his approval rating climbed to about 70 per cent. Although this level of support decreased during 1991-2, it remained relatively high at more than 50 per cent. The Christian Democratic Party was the majority party within the Concertacion. The results of the 1992 municipal elections were eagerly awaited because they would reveal the true political orientation of the population, independent of support for the president and opposition to Pinochet. In the end, however, the results of the elections did not alter the political landscape. The Concertacion remained a very important political force and within it the Christian Democratic Party maintained its majority. Support for the two other principal parties of the Con- certacion, the Socialist Party (SP) and the Partido Por la Democracia (The Party for the Democracy, or PPD), lagged significantly behind. On the right, a relative balance was attained between the Renovacion Nacional (The National Renovation Party) and the Union Democratica Independiente (Independent Democratic Union, or UDI). The Concertacion's continuance has been made possible by momen- tous changes in Chilean politics, although the coalition itself has aided the consolidation of these changes. If the military dictatorship had produced an ideological and economic revolution, replacing an economic development model that had existed for half a century, the Concertacion has brought about a true political and cultural revolution by completely transforming the traditional realm of alliances, ideas, government programme and public opinion. Chile has progressed from an antagonistic system to one that embraces negotiation and fosters agreements. From an extreme and sectarian ideological mentality emerged an ability to identify concrete issues and define common goals. Finally, a system of coalitions has developed from a multiplicity of parties and movements. This new style of politics has allowed the building of a `national agenda', based upon the major agreements that have been reached to date. This has permitted the development of a government programme free from major conflicts and, perhaps most importantly, has earned credibility in the eyes of significant social actors. This has been especially true with regard to the private sector and foreign investors, both of whom have increased investment. The economic bonanza has also contributed to these achievements. Oscar Muizoz Gomk and Carmen Caledon 217

Like all social processes, this new style of politics, or `democratic consensus' as it has been termed (Walker, 1993), is still susceptible to hazards and deterioration. First, it has not been tested by a serious economic crisis. Second, although reaching consensus is an efficient way to implement public policies, it also prohibits controversial social goals from being included in government policies. Fissures may erupt if certain sectors believe that their short-term sacrifices will not be rewarded in the future. Third, this level of political consensus requires a degree of cooperation among political party leaders, which could work against attempts to increase participation at the grass roots level, particularly if the latter feel that their views are not being taken into consideration. This situation is closely linked to the systems used by the parties and coalitions to process the demands emanating from within, and specifically the issue of party-level democracy. This problem was clearly evident in the process of selecting presidential candidates in 1992-3. The political parties were revitalised with the launching of the presidential campaign in 1992.' This period can best be characterised by the internal struggles that occurred between blocs within both the government and the opposition. In the Concertacion, after all other candidates had withdrawn, two primary candidates were chosen, one from the Christian Democratic Party and one from the PPD-Socialist Party. The difference between the two candidates lay not so much in their political platforms, but rather in their political cultures. On the right, however, the process for choosing primary candidates has been self-destructive. By the end of 1992 a succession of tactical errors had been made during the race for the candidacy. Added to these problems was the involvement of some army officers in political spying, which resulted in negative public opinion, legal action and a general discredi- ting of politics, specifically of the party involved in these affairs - Renovacion Nacional. As a result, the parties of the right had to face the presidential election of 1993 without leaders and without innovative proposals to counter those of the Concertacion programme. Therefore, it was predicted that the Concertacion would remain in office for the next presidential term. The main problem within the Concertacion has been the selection of a common candidate. Given that no formal mechanism existed, and because there was more than one primary candidate, the issue was how to select a single candidate who would be supported by all of the members of the Concertacion. Although the Christian Democrats argued that the candidate should be a Christian Democrat because of 218 Chile their wide electoral support, the Socialist Party for Democracy bloc demanded an equal opportunity to compete. They argued that if they were not given that chance it would appear that they had been relegated indefinitely to a secondary position within the Concertacion, and the coalition would run the risk of losing the support of their electoral base. The problem was resolved by the party leaders through a sort of primary election, in which a variety of social and political groups within the coalition participated. Undoubtedly this will remain an issue of party institutionality with long-run impacts.

The Socio-Economic Agenda for the 1990s

Towards the end of the Pinochet regime the most important issue was whether the economic reforms and the new economic structure it had implemented could survive a change of government and the transition to democracy. The economic reforms had been attacked on two fronts: the high social costs incurred and doubts as to their ability to endure under a fully democratic government. The social costs resulting from the initial reforms were irreversible, although when the economy adjusted and began to grow vigorously during the second half of the 1980s the social costs decreased. How- ever, the uncertainty surrounding the viability of these reforms upon return to democracy remained. The Concertacion argued, correctly in our opinion, that Chile could not withstand a structural change in the economic model. Moreover, the trend towards greater liberalisation in state-dominated economies meant that any changes in the Chilean model would be perceived as a setback by the international community. At the same time, the importance placed on economic stability and financial equilibrium increased. Once the opposition had decided to support the economic model, the next stage was to build a coalition that could successfully contest the presidential elections and foster a new way of engaging in politics with the right and with the private sector and labour. Therefore, the fundamental element of the Concertacion campaign was seeking agreement with key actors while retaining a clear view of the government's inherent responsibilities. These principles have been expressed by the president and espoused by his cabinet. Most would agree that the Concertacion government has achieved a high level of success in its first three years in office. Economic indicators have exceeded expectations and a cautious, but clearly defined, political strategy has succeeded in designing institutional reforms for Oscar Munoz Goma and Carmen Caleddn 219 the consolidation of democracy. The challenges for the remainder of the decade pertain to political as well as to economic and social issues. With regard to the latter, because a healthy economic structure has been achieved, more specific and urgent problems can now be addressed. The three principal concerns now facing Chile are improving social equity, the ability to compete economically at the international level, and the quality of public management. Social equity has been continuously debated. It is argued that high economic growth, with concomittent job creation and wage increases, should be the main instrument for reducing poverty. Undoubtedly this mechanism has been effective in Chile, but it is evident that important social groups remain marginalised from these benefits because they have been unable to join the workforce - groups such as the elderly and unskilled youth. Social programmes designed to aid these high- risk groups have been implemented, but will require continued development and increased funding. The tax reform, designed to generate funds for social projects, was only temporary. Thus, as the policy is set to expire, the issue of taxes and social responsibility has reentered political discussion. In addition to social programmes aimed at the poorest sectors of society, the subject of the quality of and accessibility to social services for the middle class is gaining importance. Critical issues include increased costs, technological changes in areas such as health and education, demand for improved quality of social services - loans, market transparency and the behaviour of intermediary agents - and wages for professional and technical staff employed in these areas. The Aylwin government has had to deal with serious conflicts in these areas, one of which led to a ministerial change. This is directly related to the subject of government reform, especially in the area of social services. It is not only a question of how the state can provide these services directly and with increased quality, but also how the market might play a greater roler in their decentralisation while simultaneously increasing efficiency where the government has over- sight responsibilities. Chile's ability to compete in the international economy will be crucial in the 1990s. In general, this is related to the problem of medium- term economic growth. More specifically, the challenge lies in maintaining a high rate of export growth. The impressive performance of the Chilean economy over the last few years tends to overshadow the fact that, historically, growth rates have been modest. From 1950-73, GDP growth was 3.4 per cent, which 220 Chile remained the average for the remainder of the 1970s but dropped to 2.9 per cent during the 1980s (Bosworth and Marfan, 1993). From this perspective the approximately 6 per cent growth since 1986 is exceptional and should primarily be considered a cyclical phenomenon; that is, recovery in the wake of the deepest economic depression since the 1930s but bolstered by the consolidation of economic reforms and the stability attained due to structural adjustments. Beginning in 1990, GDP regained its historical position and therefore recent growth is the result of a genuine expansion of productive capacity. Nevertheless, some analysts, such as Bosworth and Marfan (1993), are concerned that this recent expansion has been based principally on intensive utilisation of an unemployed and underemployed workforce. By the end of 1992 the national unemployment rate had fallen to a level that had not existed since the early 1970s (4.4 per cent), when the economy was overheated. International experience has demonstrated that long-term growth is not based on intensive utilisation of the workforce, but rather on an increase in investment and technological improvements that boost the productivity of the joint factors of production. Growth potential based on the utilisation of the workforce is less than what could be achieved with investment, either in technol- ogy or in improved quality of work. Historically, Chile has performed poorly in these areas. Therefore, a continuation of recent growth requires a strategy that emphasises capital formation and technological improvement. In the medium-term, the strategy for the export model of growth coincides with the need to improve production capabilities. In fact, the model provides incentives for increased international competitiveness, which in turn requires sustained productivity growth. The implications of a labour market characterised by low unemployment in an open economy reinforces the theory that real wages rise with sustained economic growth. If the increase is not accompanied by higher productivity, then costs rise and competitiveness falls. These conditions have been present in the Chilean economy since the early 1990s. Growth in labour productivity can be achieved with an increase in the ratio of capital per worker but also by increasing overall productivity. While the first involves saving and investment, the second is concerned with technological innovation and increased quality, in particular the education and training of the workforce. Increased saving and investment is one of the strategic goals of the macroeconomic policy for the 1990s. However the main objective of the industrial policy is technological innovation. Unlike the industrial policy adopted during Oscar Munoz Goma and Carmen Caledon 221

ISI - based on public investment and on the manipulation of incentives for private investment in a selective and discriminatory fashion - the 1990s call for a new industrial policy focusing on the development of technological and educational capability, which constitute the foundation of the export-oriented model. Such a policy will also have to incorporate environmental protection standards in order to counter threats to the environment posed by the fact that intensive use of natural resources can bring about a high rate of return. However, these standards should be evaluated in terms of their long-term benefits and social costs. The Concertacibn will also have to address the need for state reform to improve its regulatory functions. Given that these functions are increasingly being subjected to market forces, the state must provide appropriate institutions, using a system of incentives and disincentives, to guarantee the protection of social interests. The regulatory role of the state gains importance, not by increased bureaucracy and interventionism, but rather through adequate signals to the market and by ongoing efforts to enhance market institutions.

Notes

1. This paper was sponsored by IDRC of Canada. While Juan Jiles cooperated with the statistical work for this paper, the authors take full responsibility for its contents. 2. Between January and December 1991 the libor interest rate fell by close to 3 percentage points, from 7.3 per cent to 4.6 per cent. 3. According to the Constitution, the Aylwin government may only remain in power for four years (until March 1994).

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Accibn Democr3tica Nacionalista Convertibility Plan 14-15, 86-9 (ADN, Nationalist Democratic dollarisation 16, 76, 89 Action) 35, 38 economic crisis 50-1, 56-9, adult literacy 119, 120 92-3 Aerolineas Argentinas 84 `Economic Emergency' law 79 aforo system 174, 188 economic indicator tables 96-105 aggregate demand and supply 150 economic inheritance of agriculture democracy 59-62 livestock production in elections 66, 72-3 Uruguay 137-8, 139, 164 exchange rate see exchange rate Paraguay 167, 170, 172, 178; executive power 17 conflicts 180-1 human rights violations 26, 72, Alderete, Minister of Labour 72, 74 214 Alfonsin, Raul 7, 8, 51 hyperinflation 9; first 52, 74-7; early resignation 14, 77 second 81, 81-3 Alfonsin government 24, 50, 51, imposed transition 3 63, 66 inflation see inflation see also Argentina investment 19, 52, 97 Alianza Renovadora Nacional Menem government 16-17, 52, (ARENA) 25, 112 77-8 Alianza Encuentro Nacional military regime 3, 4, 9, 53-9; (AEN) 183-4 accumulation with financial Angeloz, Eduardo 76 repression 53-5; financial Argentina 2, 7, 27, 49-111 liberalisation and crisis 56-9; adjustment problems 62-92; high inflation 5, 55-6 economic emergency and Paraguay: aid 167, 170; structural reforms 71-4; MERCOSUR 186 `exchange rate revolution' political parties 23-4, 24-5, 66, 81-3; Extended Fund Facilities 71-3, 92-3 and Brady Plan 90-2; private sector 21, 59 optimistic diagnosis and first `Punto Final' law 72 failure 62-4; post- stabilisation see stabilisation hyperinflationary State Reform Law 79 consensus 83-4; privatisation structural reforms 18-1 9, 71-4 and debt/equity swaps 89-90; unions 8, 23, 51, 55, 6 3, 70, 80 rapid exchange rate Uruguayan trade with 152 appreciation 84-6 armed forces 26 Austral Plan see Austral Plan Argentina 78; military banks 5, 58, 70, 94; exchange insurrection 72, 76-7, 84 rate bubble 82-3 Chile 214, 215, 217 BB Plan 78-81 see also military governments Central Bank 58, 59, 76, 82-3, Asuncion Para Todos 183 84 austerity 180

231 232 Index

Austral Plan 10, 13-14, 64-71 Paz Zamora administration 38 external shock 67-8 political parties 23-4, 24, 45-6, increasing pressures 68-71 46 persistence of inflation 66-7 private sector 21-2, 43-4, 45 Aylwin, Patricio 192, 212, 216 privatisation 44-5 Aylwin government 12-13, 21 public sector see public sector relations with private sector 21, Siles Zuazo government 7, 22, 200-4 23, 24, 31-2 strategy options 192-4 stabilisation 10-11, 15, 15-16, see also Chile 30; NEP 35-6, 37 transparency in decision balance of payments 4 making 41-3 Argentina 53-5, 59, 59-60, unions 8, 23, 33, 37 85-6, 96, 101; external bonds, treasury 152, 154 shock 67-8 Bonex Plan 82

Brazil 1 15 Bosworth, B. 220 Chile 193, 208-9, 211 Brady Plan 87, 89, 90-2 see also trade balance Brazil 2, 26, 27, 112-36, 170 Banco Nacional de Desarrollo clientelism and state corporatism (BANADE) 90 7-8, 113-14, 126-7 banks/banking 5 economic crisis 124, 133-4 Argentina 5, 58, 70, 94; education system 114, 121-4, exchange rate bubble 82-3 130-3 Paraguay 175-6, 184-5 growth with debt 4 Uruguay 156 imposed transition 3 Bano, R. 215 income distribution 113, 118-19, Barros, R. P. 118 119, 120, 122, 123 Barros de Castro, A. 113 inflation 5, 115, 117 BB Plan 78-81 macroeconomic background Bolivia 2, 19, 27, 30-48 115-18 debt crisis 6 military regime 3, 9, 25, 112, democratic transition 30, 31-4, 113 46; first administration 31-2; Paraguay: aid 167, 168, 177; political disintegration 34; MERCOSUR 186 political obstacles to economic political parties 25 management 32-4 responses to budget cuts 130-3 dollarisation 16 social fragmentation and exchange rate 15, 27 crisis 125-30 human rights violations 26 social record 119-21 hyperinflation 9, 30, 32, 33, 34 stabilisation 9, 10, 14, 115 imposed transition 3 trade with Uruguay 152 inflation 15-16, 32, 37 unions 8, 23, 113, 125 investment 19, 43-4 Brazilian Democratic Movement military regime 3, 34 (Movimiento Democrfitico New Economic Policy see New Brasileiro, MDB) 25, 112 Economic Policy Bressner Plan 14 opposition to NEP 45-6 Biichi, Hernan 191-4 Paz Estenssoro government budget cuts 130-3 16-17, 22, 34-5, 37 see also public expenditure Index 233

Budnevich, C. 200 adjustment policy 205-9; Bunge and Born 78 external debt 211-12; foreign bureaucracies 132-3 exchange market 209-11 bureaucratic rings 127 military regime see military business community see private governments sector planned transition 3 Butelmann, A. 206 political parties 216-18 poverty 27-8, 200, 219 Caballero Vargas, Guillermo 182, presidential elections 191-2, 183 216, 217-18 Cafiero, Antonio 74 private sector 20-1, 198, 200-4, Campo de Mayo 72 212 Campos, D. 179 social market economy 195-204; capital flows distributive equity 195-200; Argentina and Brady Plan 91-2 private sector reaction 200-4 debt crisis 5-6, 9 stabilisation 10, 12-13 inflows to Paraguay 168 strategy options for democratic Uruguay 139, 141, 155 transition 191-4 Cardoso, F. H. 127 structural reforms 18 Cavallo, A. 212 unions 22, 198 Cavallo, Domingo 85 Christian Democratic Party 216, Celed6n, C. 206 217, 217-18 Central Banks 209 clientelism 7-8, 113-14, 118, see also under individual 126-7 countries Collor de Mello, Fernando 112 Central Obrera Boliviana Collor Plan 14 (COB) 33, 37 Colorado Party 26, 166, 181, Central Unitaria de Trabajadores 182-4 (Workers Central) 198 Comisibn de Relaciones Certificados de Cr6dito Tributario Econbmicas Internacionales (tax credit certificates) 194 (Commission of International Chile 1-2, 6-7, 27, 191-222 Economic Relations) 204 adjustment policy 1990 203, Comisibn Verdad y Justicia (Truth 205-9 and Reconciliation Central Bank 203, 207, 210 Commission) 214-15 consensus 8 command over resources 131-2 debt crisis 5 competitiveness, international 194, democracy and governability 219-20 212-21; institutional Concertaci6n Nacional Programi tica equilibrium 213-15; (CONAPRO) 22, 147, 148, socio-economic agenda 164 for the 1990s 218-21 Concertaci6n de Partidos por la exchange rate 27, 209-10 Democracia (Coalition of external sector liberalisation 3-4, Parties for Democracy) 12, 209-11 213-14 human rights violations 26-7 political parties 216-18 inflation 5, 205-9 private sector and 20-1, 200-4 investment 19, 194, 207 strategy options 192-4 macroeconomic policy 204-12; see also Chile 234 Index

Conciencia de Patria (Patriotic first governments 6-10 Awareness) 45-6 inheritance of military Confederacibn de Empresarios governments 3-6 Privados de Bolivia (CEPB, interactions between politics and Bolivian Confederation of economics 20-7 Private Entrepreneurs) 21-2, stabilisation programmes 10-13 33, 44 development, economic see Confederacibn General del Trabajo economic development (CGT, General Federation of distribution Labour) 23, 80 Bolivia 45 Confederacion Paraguaya de Brazil 112, 113, 115, 125; Trabajadores (CPT) 182 education system Confederacion de la Produccion y asymmetries 121-4 el Comercio (Confederation of equity in Chile 195-200 Production and Trade) 198, resources 20, 36-7 201 Uruguay 157-61, 162 consensus see also income distribution Argentina 83-4 diversification 138 Chile 216-17 dollarisation 16 construction 170, 172-3 Argentina 16, 76, 89 contracts Uruguay 16, 154-5, 156-7 dedollarisation 7 domestic spending 207-8, 209 indexed see indexed contracts `domestic transfer' problem 60-1, conventions 129-30 118 Convertibility Plan 14-15, 86-9 drug trafficking 32 Corporacion Minera de Bolivia (COMIBOL) 36, 41 economic development corporate taxation 196, 197 ISI model in Argentina 53-5 corporatism, state 7-8, 113-14, Paraguay 172-3, 184-7 126-7 Uruguay 146-7, 163 Couriel, A. 140 economic growth 4 Cruzado Plan 10, 14 Argentina 52-3, 53, 96 current account see balance of Brazil 115, 116 payments Chile 193, 194, 204-5, 207, 220 Paraguay 167, 168, 169-70, 172 Davrieux, H. 161 education debt crisis 4-6, 9, 133 Bolivian expenditure 40, 41 see also external debt Brazil 20, 114; debt/equity swaps 89-90 asymmetries 121-4; budget decision making cuts-130-3 transparency in Bolivia 41-3 Chile: expenditure 200; Uruguay 158 productivity and 220-1 dedollarisation of contracts 7 Uruguayan expenditure 160-1, demand and supply 150 173, 175 democratic consensus 216-17 employment democratic transition 1-29 Argentina 102 economic reforms 18-20 Bolivian public sector 41, 42 failed stabilisations and second- Paraguay 168-9 round successes 13-17 see also unemployment Index 235

Empresa Nacional de external sector liberalisation 3-4 Telecommunications (ENTEL, Chile 3-4, 209-11 (National Telecommunications Uruguay 3, 3-4, 139, 151-2 Enterprise) 84, 105 see also trade liberalisation entrepreneurs 33, 37 see also private sector Fadlala, E. 186-7 equity 195-200, 219 Falklands War 51, 59 estimated income, taxes on 196, FEPRINCO 179, 180 197 Figueiredo, General 112 exchange rate 5, 15, 27 financial liberalisation 56-9 Argentina 15, 27, 60, 76, 98; financial repression 53-5 BB Plan 79; Convertibility first transitional governments 2, Plan 86, 88; gap 80-1; 6-10 military regime 57, 58; fiscal deficits Primavera Plan 74-5; rapid Argentina 97 appreciation 84-6; Brazil 114 `revolution' 81-3 Uruguay 140, 147, 148. 152, Bolivia 15, 27 153, 162 Brazil 117 fiscal policy 20 Chile 27, 209-10 Argentina 73-4; Austral Paraguay 174-5 Plan 65, 68-9; Convertibility Uruguay 12, 27, 145, 148, 156, Plan 86, 87, 88 162; external sector Chile 210 liberalisation 151-2; tablita Paraguay 185 140-1 Uruguay 148; fiscal problem executive power 16-17, 94-5 153 exit strategy 128-9, 131-2, 135 see also taxation expectations 128 Fondo de Estabilizacion del Cobre expenditure, public see public (Copper Stabilisation expenditure; social expenditure Fund) 197 exports Fondo de Inversion Social (Social Chile 206, 207; growth Investment Fund) 41 model 220-1 Fondo Social de Emergencia (FSE, Uruguay 162; promotion 139 Emergency Social Fund) 4] see also trade liberalisation foreign exchange market 209-10 Extended Fund Facilities 90-2 see also exchange rate external debt Foxley, A. 205 Argentina 52, 58, 60-1, 98, 99; fragmentation, social 125-30 Extended Fund Facilities and Franco government 14 Brady Plan 90-2; Frischtak, L. L. 127-8 privatisation with debt-equity swaps 89-90 Geisel, General 112 Brazil 116, 117-18, 135 General Confederation of Workers Chile 210, 211-12, 213 (Confederaci6n General del debt crisis 4-6, 9, 133 Trabajo, CGT) 23, 80 domestic transfer problem 60-1, Generalized System of 118 Preferences 176 Paraguay 170-1, 177 Gonzalez, Minister of Economy Uruguay 140-1, 152, 155, 162-3 85 236 Index governability Brazil 113, 118-19, 119, 120, Chile 212-21 122, 123 obstacles to in Bolivia 32-4 Chile and equity 195-200 governance capacity 94-5 Uruguay 157-61, 162 gross domestic product (GDP) income transfers composition in Argentina 100 Chile 199-200 and public spending in Uruguay 158-9 Bolivia 39 see also capital flows Uruguay 138; fall 139-40, incomes policy 64, 70, 74 142-3; recovery 149-50, 161, indexed contracts 9 162 Argentina 57, 62; Austral see also economic growth Plan 65, 67; Convertibility Gulf War 207 Plan 86, 88; high Guzmdn Errazuriz, Jaime 215 inflation 55-6 Chile 207 Hachet government 12 industrial policy 220-1 health expenditure industry: Paraguay 172 Bolivia 40, 41 see also manufacturing Chile 200 infant mortality 119, 120 Uruguay 160-1 inflation 5, 27 Heredia, R. 201, 202 Argentina 64, 84, 96, 106; higher education 121, 122, 123, Austral Plan 66-7, 70-1; BB 124, 132 Plan 79; Convertibility Plan Hintermeister, A. 160 87; military regime 55-6, 57 Hirshman, A. 131-2, 135 Bolivia 15-16, 32, 37 `Hobbesian natural state of Brazil 5, 115, 117 society' 129 Chile 5, 205-9 homogeneous societies 125-6 indexed contracts 9 housing budget 200 Paraguay 178 human rights violations 26-7, 72, Uruguay 5, 145, 153-7, 158, 214-15 160 hydroelectric projects 168, 170, see also hyperinflation; 187 stabilisation hyperinflation 9, 11, 94-5 infrastructure 167, 168 Argentina 9; first 52, 74-7; institutional modernisation 184-7 second 81, 81-3 Institute de Bienestar Rural Bolivia 9, 30, 32, 33; political (IBR) 180-1 disintegration 34 interest groups 127-8 see also inflation see also social groups/movements interest rates import substitution industrialisation Argentina 102 (ISI) Brazil 115, 117 Argentina 53-5 Chile 207, 208, 210 Uruguay 138 Paraguay 179 imposed transitions 3, 6 Uruguay 152, 156-7 incentives, production 139 internal transfer problem 60-1, income distribution 118 Argentina 103 international competitiveness 194, Bolivian NEP 45 219-20 Index 237 international financial institutes election campaign 75, 108 (IFIs) 9, 18 liberalisation and public sector see also under individual names reform 81 International Monetary Fund loss in popularity 95, 108 (IMF) 93 need for stability 24-5 Argentina 75, 87, 88, 94; political shift 77-8 Extended Fund Facilities 90-2 Menem government 16-17, 52, 77-8 Bolivia 10-11, 42 see also Argentina Paraguay 174, 180 MERCOSUR (Southern Cone Uruguay 147, 148, 156, 163 Common Market) 176-7, 185, investment 27, 220 186-7 Argentina 19, 52, 97 migration 167-8, 169, 173 Bolivia 19, 43-4 military governments Brazil 115, 116 Argentina see Argentina Chile 19, 194, 207 Bolivia 3, 34 Paraguay 167; code 176 Brazil 3, 9, 25, 112, 113 private 19, 43-4, 194 Chile 3, 5, 201; defeat through public 97, 115, 116, 151 political mechanisms 213-14; Uruguay 19, 140, 143, 150-1 strategy options for Itaipu project 167, 168 demographic transition 191-4 economic legacy in Paraguay 2-3, Katzman, R. 161 167-71, 185-6 inheritance 3-6 labour institutionality 197 political parties 25 labour legislation reform 192-3, military insurrection 72, 76-7, 84 197-8, 202 minimum wage 199-200 Labour market 143, 199 monetary assets 61, 65, 100 see also employment; monetary policy unemployment Argentina 65-6, 69-70, 88-9 Laino, Domingo 183, 184 Chile 210 land 180-1 Uruguay 147-8 law, adherence to 129-30 Montero, C. 201, 203 Leftist Revolutionary Movement Morales, J. A. 45 (Movimiento de Izquierda Movimiento Democratico Brasileiro Revolucionaria, MIR) 24, 38 (MDB, Brazilian Democratic life expectancy 119, 120 Movement) 25, 112 literacy, adult 119, 120 Movimiento de Izquierda livestock production 137-8, 139, Revolucionario (MIR, 164 Revolutionary Left-Wing Movement) 24, 38 Macadar, L. 140, 150, 163 Movimiento Nacionalista manufacturing Revolucionario (MNR, Paraguay 186 Nationalist Revolutionary Uruguay 139, 140 Movement) 24, 35 Marfan, M. 220 municipalities 36, 47 Masi, F. 186-7 Melgar, A. 160 National Renovation Alliance Mendonca, R. 118 (Alianca Renovadora Nacional, Menem, Carlos 14, 52, 74, 77, 84 ARENA) 25, 112 238 Index

Nationalist Revolutionary social movements 8, 185 Movement (Movimiento stabilisation 13, 174-8, 184 Nacionalista Revolucionario, unions 23, 181-2 MNR) 24, 35 Paraguayan Campesino Movement Neves, Tancredo 28 (Movimiento Campesino del New Economic Policy (NEP) 30, Paraguay) 180 30-1, 35-46 Paris Club 177 contents 35-7 particularist/universal conflict 128,134 continuation under Paz Partido por la Democracia (Party Zamora 38 for the Democracy, PPD) 216, new interpretation of initial 217, 218 success 37 Partido Liberal Radical Authentico prospects 43-6; (PLRA) 183-4 beneficiaries 45; populist Patriotic Agreement (AP) 38 parties 45-6; private Paz Estenssoro, Victor 36, 44 investment 43-4; Paz Estenssoro government 16-17, privatisation 44-5 22, 34-5, 37 public sector reform 38-41 Paz Zamora government 38 transparency in decision 'peaceful' stabilisations 11-13 making 41-3 Per6n, Isabel 56 Noya, N. 150, 162 Per6n, Juan 55 Peronism 21, 63, 92-3 O'Donnell, G. 129 elections 66, 72-3, 77 oil crisis 1974 139 ideological turnabout 52, 77-8 oil price 207 Menem 74, 77-8 open market operations 209 `renovated' 71 organisation, degree of 131-3, 135 and tax reforms 69 Overseas Private Investment and unions 51 Corporation 176 Pinochet, General 212 Oviedo, Lino 183 Pinochet government 5, 201 planned transitions 3, 6 Pacto por la Democracia (Pact for `poliarchic' state 129 Democracy) 35 policy making see decision making Paraguay 2, 6, 17, 26, 27, 166-90 political movements 185 economic policy and democratic political parties 23-6 transition 174-84 Argentina 23-4, 24-5, 66, 71-3, economic structure 169 92-3 economy in transition 172-4 Bolivia 23-4, 24, 45-6, 46 elections 166; presidential 182-4 Chile 216-18 institutional modernisation and Paraguay 26, 182-4 economic development 184-7 Uruguay 25, 146 legacy of Stroessner regime 2-3, see also under individual names 167-71, 185-6 politics macroeconomic indicators 177 Bolivia: obstacles to economic planned transition 3 management 32-4; political political parties 26, 182-4 disintegration 34 private sector 21, 174, 179-80 interaction with economics during Rodriguez government see transitions 20-7 Rodriguez government of stabilisations 16-17 Index 239

Popular Unity (Unidad Popular) 24 quasi-rents 55 populist parties 45-6, 46 poverty 27-8 Radical Party 21, 63, 66, 73, 92-3 Brazil 113 Rama, M. 162 Chile 27-8, 200, 219 regional development corporations Uruguay 161 (CRDs) 36, 47 primary education 122, 123, 124 Rehren, A. 201, 202 Primavera Plan 14, 74-6 Renovati6n Nacional (National private investment 19, 43-4, 194 Renovation Party) see also investment 196, 197, 216, 217 private schools 122-4 `renovated Peronism' 71 private sector 20-2 repression, financial 53-5 Bolivia 21-2, 43-4, 45 resource distribution 20, 36-7 debt: Argentina 59; Brazil 117, resources, command over 131-2 135; Chile 212; Rico, Lt Col. Aldo 72 Uruguay 141, 154 Riquelme, M. A. 183, 183-4 relationship to government: 'Rodrigazo' 55 Chile 198, 200-4; Rogriguez, Gen. Andres 2-3, 172, Paraguay 174, 179-80 174, 181 privatisation role in democratic transition 166 Argentina 52, 87, 105; debt- Wasmosy 182 equity swaps 89-90 Rodriguez government 2-3, 8, 10, Bolivia 44-5 13, 174-82, 184-5 productivity 220-1 divisions within 178-9 Programa de Capacitaci6n Laboral private sector 21, 174, 179-80 de J6venes (Youth Training see also Paraguay Programme) 200 provincial banks 70 Saguier, Miguel Abdon 184 public expenditure SSnchez de Lozada, Gonzalo 36 Bolivia 39 Sanguinetti government 25 Brazil: education 122, 123, 124; see also Uruguay response to cuts 130-3 Santos, W. G. 129 Paraguay 173, 175, 176, 195, Sarney, Jos6 7, 8, 25, 28, 112 200 see also Brazil social see social expenditure savings Uruguay 163-4 Argentina 53; external 60, 97 public investment 97, 115, 116, 151 Chile 205 see also investment 'second transition' governments 2, public sector 27 13-17 Argentina 71-2, 99 secondary education 122, 123, 124 Bolivia 36, 38-43; sectoral accords 72 employment 41, 42; public sequencing of reforms 18 spending and GDP 39; social shock stabilisation programmes expenditure 40, 41; tax 10-11 collection 40 Siles Zuazo, Hernan 7, 8, 33 Brazil 117 Siles Zuazo government 7, 22, 23, Paraguay 175 24, 31-2 Uruguay 148, 153 social conflict see also state Argentina 76-7 240 Index social conflict continued and structural reforms 18-19 Bolivia 34 Uruguay 9-10, 11-12, 16, 147-8 Paraguay 180 state social expenditure capture of 127-8 Bolivia 40, 41 Brazil: society and state 125-30, Brazil 119-21 133-4 Chile 195, 200 role: Argentina 50-1, 56, 94-5; Uruguay 160-1 Bolivia 36-7; Chile 221; see also public expenditure Uruguay 158 social fragmentation 125-30 see also public sector social groups/movements 7-8, state corporatism 7-8, 113-14, 146, 185 126-7 social market economy 195-204 state education 20, 122-4, 132 distributional equity 195-200 see also education reaction of private sector 200-4 statecraft, wretched 127 social pacts 8 ,stop-go' models 53-4 social policy Stroessner government 2, 166, Brazil 119-21 182 Chile 192-3, 193-4, 199-200 economic legacy 167-71, social security 185-6 Bolivia 40 structural reforms 18-20 Brazil 121 Argentina 18-19, 71-4 Chile 200 Bolivia 30; NEP 35-6, 37 Uruguay 158, 160 Paraguay 184-5 social services 219 Summer Plan 14 Socialist Party (SP) 216, 217, 218 supply 147, 150 Solidarity and Social Investment Fund (Fondo de Solidaridad e tablita 59, 140-1 Inversion Social, FOSIS) 200 tariffs Souza, F. E. P. 113 Argentina 79, 82, 104 stabilisation 1, 9-10 Chile 210 Argentina 9, 15, 16, 51, 94; Uruguay 148 Austral Plan 64-71; taxation Convertibility Plan 52, 86-9; Brazil 118 military government 57; Chile 210; reform 194, 195-7, orthodox 64; Primavera 202 Plan 74-6 collection in Bolivia 40 Bolivia 10-11, 15, 15-16, 30; Paraguay 173, 175; NEP 35-6, 37 reforms 179 Brazil 9, 10, 14, 115 see also fiscal policy economics of stabilisations 15-16 teachers 132 failed programmes and second- salaries 122-4 round successes 13-17 technocrats 31, 32-3, 42 Paraguay 13, 174-8, 184 technological innovation 220, politics of stabilisations 16-17 220-1 programmes during terms of trade transition 10-13; `peaceful' Argentina 67-8, 101 programmes 11-13; shock Brazil 117 programmes 10-11 terrorism 215 Index 241

Torre, J. C. 8, 94-5 Treasury Department and trade balance Primavera Plan 76 Chile 208-9 universal/particularist conflict 128, Uruguay 140, 151 134 see also balance of payments Uruguay 2, 6, 27, 137-65 trade liberalisation Central Bank 141 Argentina 71-2 changes in income and factor Paraguay 176-7, 179 distribution 157-61 Uruguay 148 constitutional government's see also external sector economic policy 141-9 liberalisation debt crisis 5 trade unions see unions dollarisation 16, 154-5, 156-7 transition to democracy see domestic disequilibria 153-7 democratic transition exchange rate see exchange rate transparency 41-3 external sector liberalisation 3, treasury bills 152, 154 3-4, 139, 151-2 'trial of responsibilities' 26 human rights violations 26, 214 inflation 5, 145, 153-7, 158, 160 Ubaldini, Saul 80 investment 19, 140, 143, 150-1 unemployment legacy of the crisis 139-41 Argentina 103 major trends 137-9 Chile 199, 220 planned transition 3 Paraguay 177, 181 political parties 25, 146 Uruguay 139-40, 143, 150 private sector 21, 141, 154 see also employment recovery and adjustment 149-51 Unidad Democratica Popular (UDP, social groups 8, 146 Popular Democratic stabilisation 9-10, 11-12, 16, Alliance) 31, 33 147-8 Union Civica Solidaridad (UCS, structural reforms 18-19 Solidarity Civic Union) 45-6 unions 8, 22-3 Union Democratica Independiente (UDI, Independent Democratic value added tax (VAT) 197, 207 Union) 216 Vial, J. 206 Union of Paraguayan Industries voice strategy 128-9, 131-2, 135 (UIP) 179, 180 unions 8, 22-3 wages Argentina 8, 23, 51, 55, 63, 70, Argentina 62, 67, 88, 98, 156 80 Chile 199; minimum 199-200 Bolivia 8, 23, 33, 37 Paraguay 168-9, 181 Brazil 8, 23, 113, 125 Uruguay 139-40, 145, 161; Chile 22, 198 adjustment mechanism 148-9; Paraguay 23, 181-2 recovery 158-9, 160 United Nations Organization for wages councils 148-9, 160, 164 Industrial Development Walker, I. 217 (UNIDO) 172 'Washington consensus' 18, 52 United States 178, 210 Wasmosy, Juan Carlos 2, 26, 166, Generalized System of 181, 182-3 Preferences 176 Weber, M. 129-30 and Paraguay 167, 170, 176 welfare state 125 242 Index

Werneck, R. F. 127, 128 Chile 200 Weyland, K. 125, 126 Paraguay 174 Williamson, J. 18 Workers' Party (Partido de los Yacimientos Petroliferos Fiscales Trabajadores, PT) 25 Bolivianos (YPFB) 36 World Bank 93 Yacyreta project 170, 187 Argentina 75-6 Brazil 119 Zalaquett, J. 214