The questions and threats looming over Latin American post-covid economics

The ‘Lost Decade’, hyperinflation, recession, and defaults are all familiar terms for Latin American countries. Throughout much of its history, the Latin American region has resented corruption and underdevelopment. The current pandemic-induced global recession threatens the region’s weak economic stability, with a sizable number of the region’s countries already deep into debt as a direct product of past and current governments’ mismanagement of the State’s finances, since public sector corruption and inefficiency, along with its induced debt, have drained countries’ public coffers. As a result, 21st century Latin America is a story told by crooked state officials, stagnated economies, weak governments, populists, and a vastly unequal population, whose conspicuous majority are lower-middle income people deprived of opportunities of social mobility.

In the recent past, to cope with global recessions such as the one currently being faced due to COVID-19, Latin American countries have relied on short-term solutions such as increasing the size of the public sector to provide jobs when unemployment rises (resulting in further deepening public debt), or asking for credits from multilateral organizations such as the International Monetary Fund (IMF) to repay debt. This results in the conditioning of their fiscal policy to meet certain targets stipulated by the IMF, leading to fiscal contraction and opening the economy to the free market, which induces an immediate reduction in public spending on social welfare, thus halting economic growth, worsening human development, and increasing inequality.

Evidently, these crises (notably the 1980’s debt crisis and the 2008 financial crisis) have led to contemporary Latin America, which sits in the brink of further debt and even default in economies shattered by instability and corruption such as Argentina and Venezuela, whose rampant inflation and currency depreciation will not sit well with the current capital flight occurring throughout the region, as the shadow of de-globalisation emerges over the international economy. To prevent the perpetuation of corruption, inequality, and underdevelopment, one must ask: is this a time to look at other alternatives and seek an economic model that increases human development, aiming for a better distribution of wealth, higher standards of living, greater economic independence, and also a lesser ecological footprint? Is this a time to start again or start over?

Re-structuring the State and seeking inclusive economic growth

Moving forward from this crisis presents what could be the most important set of decisions made by policy makers in the entire 21st century, for it could mean the reset of the region towards a more balanced economy, taking into consideration social welfare, debt containment, ecological footprint, and fair distribution of wealth.

Latin American decision-makers will have to decide whether to fall back into old short-term economic strategies of seeking credit to repay debt at the expense of social welfare and maintaining big and inefficient public sectors, or pursue new alternatives of sustainable and inclusive economic growth such as microfinancing, along with socially and ecologically conscious paths of development, seeking as a whole to improve the quality of life of average Latin Americans. To implement these economic programs, a complete reassessment of the State’s structure is essential to achieve an allocatively efficient and better distributed economy in the majority of the region’s countries, as deeply ingrained corruption within the public sector, along with its robust and inefficient bureaucracy, make political and economic governability knotty, strenuous, and deficient.

Over the last decade, Latin American countries have continued to sustain increasing debt as a result of an ever expanding public sector which has drained the State’s finances, as the offering of a greater number of jobs has resulted in bigger union power and higher costs in sustaining benefits for public employees, such as pension funds and significant severance payments, which have disincentivized the firing of employees. This increment of the public sector’s size can be traced back to the 2008 financial crisis. To prevent a rise in unemployment levels, Latin American governments introduced more public sector jobs. Such was the case in countries like Venezuela, in which the public sector provided 100,000 new jobs to cushion (arguably in an excessive manner) the 30,000 job losses that were suffered in the private sector (Santarcángelo, Justo, & Cooney, 2016). Unsurprisingly, 10 years after the financial crisis, Venezuela’s debt as a percentage of GDP amounted to 80.9%, the highest in the region. Other countries who had implemented similar measures after the financial crisis with populist governments in place like Argentina, Brazil, and El Salvador directly followed, with debt as a percentage of GDP of 80.0%, 78.0%, and 76.3%, respectively (Jaramillo, 2020).

While having high debt as a percentage of GDP is not unique to the region (developed nations such as the US and Japan have percentages of way over 100%), weak Latin American economies struggle to pay back the debt and the additional interest payments that it entails. Thus, countries must regulate expenditure in much needed infrastructural, educational, and social security projects, to balance sustaining the high costs of their big public sectors and paying back debt (often recurring to multilateral organisms such as the International Monetary Fund for credit). This evidently hinders the economic development of nations, therefore, a new, more inclusive development route must be followed, as will be referred later.

Prior to discussing new pathways of economic growth, it is of vital importance to correct major issues regarding statal corruption, bureaucracy, and negligence, all of which have prevented the region’s sustainable economic development and have built mounting debt. In 2019, the Corruption Perceptions Index (CPI), gave low and preoccupying scores regarding political corruption to the vast majority of Latin American countries, with more than 2/3 of the countries receiving scores below 50 out of 100 (Transparency International, 2019). This factor weighs heavily in mitigating foreign investment and preventing the proper execution of economic projects, ranging from infrastructure to fiscal plans.

Along with this comes the burden of the inefficient public sector which was previously discussed, which comprises a range of different institutions, statal unions, and political positions, whose objectives are unclear or simply under-accomplished. The strong political power that these actors hold over the government’s capacity to develop new economic strategies to cut public spending and consequent debt has led to the rise of populist governments, either right-wing or left-wing, characterized by a deeply rooted resentment towards the State’s incompetence in dealing with inequality due to the incorrect allocation of resources (as a consequence of bureaucracy and the corruption ingrained within it), thus leading to anti-establishment movements rising to power.

One of the clearest examples of this can be given by the case of Argentina, where “forced debt restructurings, exacerbated by excessive government spending and widespread corruption, erodes domestic and international confidence.” Argentina deals with a massive public sector and a strong and unbalanced union power, with over 40% of workers unionized and “used to extracting concessions and protections from previous free-spending populist governments” (Friesen, 2019). As a result, Argentina runs the second highest debt as a percentage of GDP in the region, and the lack of confidence its unstable economy projects has resulted in a history of depreciation of the peso (the national currency) and rampant inflation, of 53.55% by 2019 (Plecher, 2020).

As a result, Argentina has constantly turned to multilateral organizations, notably the International Monetary Fund (IMF), for credit to repay the mounting debt which the country is unable to repay. The direct consequence of this is the economic dependency that this action entails, as the IMF gives credits to countries under conditions to meet certain targets. These conditions are notorious for their severity. Most recently, Argentina asked for an IMF loan for the 22nd time in the last 60 years in June 2018, receiving a $50 billion loan, the biggest loan ever granted by the IMF in history. The conditions for this loan included major fiscal contraction, which incurred in the reduction of government spending and the reduction of subsidies on basic services (Friesen, 2019). With the current economic crisis at hand, Argentina faces default on the IMF loan, which would cause yet another debt restructuring and further economic damage (Binetti, 2020).

Whereas a clear unique solution to the problematic of negligent and corrupt public sectors is non-existing, the different situations that the different countries of the region face in these regards must be sorted through a pragmatic approach, in which unyielding institutions and political positions, along with blatantly crooked officials and statal unions, and unjustified (and unsustainable) benefits to public servants, are to be either reformed or completely disposed of. A possibility would be to rely on the guidance of international institutions which can provide studies and investigation of both public sector efficiency and corruption.

For example, the Interamerican Bank of Development (IBD), computes indicators such as Public Sector Performance (PSP) and Public Sector Efficiency (PSE) to measure the efficiency of public spending in Latin American countries. Using these particular indicators, the IBD concluded for the 2001-2010 period, that “PSE is inversely correlated with the size of the government” and “more transparency and regulatory quality improve the efficiency scores, while more transparency and control of corruption increase output-oriented efficiency” (Afonso, Romero, & Monsalve, 2013). In the respect of political corruption, UN international commissions against impunity to investigate high-level crimes can be set up in Latin American countries, as was the case of Guatemala with the establishment of the CICIG (International Commission against Impunity in Guatemala) from 2006 to 2019. The CICIG was able to lead several investigations of high-ranking government officials, including a president and vice-president (both of which were forced to resign and have been criminally prosecuted since), uncovering different criminal arrangements within the Guatemalan political class (Abbott, 2019). Hence, internationally-managed commissions which can investigate and prosecute objectively corruption within Latin American countries’ governments, show great potential of being effective solutions to control political corruption. Moving forward with this difficult first step of restructuring the State, reducing bureaucracy, and halting corruption, can mean the beginning of a new development path for the region.

With a responsible administration of the State’s finances, relapsing into the loss of economic independence by taking on loans from multilateral organizations could potentially be avoided, and investment in the average people’s economic development can be adequately carried out. Financial education, technological capacitation, and the creation of microfinance schemes stand-out amongst different alternatives to generate long-term economic growth which is inclusive for all members of the population, in an attempt to stop the poverty trap cycle.

The poverty trap is defined by Northwestern University as “a self-perpetuating condition where an economy, caught in a vicious cycle, suffers from persistent underdevelopment.” In simpler terms, the poor stay poor and the rich stay rich, while the economy stagnates. As it is known, this cycle is experienced throughout the Latin American region. With unstable economies burdened by debt and corruption, the allocation of public funds towards schemes that can actually break this cycle and thus generate a better distribution of wealth are sadly uncommon. Nevertheless, as previously stated, with the proper allocation of the State’s resources, schemes such as microfinancing have the potential to be implemented and break the cycle. Microfinancing itself is not done by the State, but financial education and technological access and capacitation for the population are crucial components of the scheme to enable the population to access these programs.

Microfinancing is a set of financial services provided by Microfinancing Institutions (MFIs), whose goal is that low-income households can develop their own businesses which can repay these services and then be able to access traditional bank loans, sustained by their growing and stable businesses. The best-known component and arguably the core of microfinancing are microcredits, which are “loans offered to (...) individuals who lack collateral and credit history. This capital can give new, low-income entrepreneurs the injection needed to get started. The goal of microcredit is to empower poor communities across the developing world to start their own businesses and enter the economy” (D'Angelo, 2020).

According to Claudio Gonzalez-Vega, who has taken leading roles in several microfinancing projects in countries such as Bolivia and Mexico, both financial education and widespread access to technology for customers are essential factors to achieve financial inclusion through microfinancing (BBVA, 2018). Therefore, after stabilizing state finances, governments should invest in social inclusion programs which can enhance the financial knowledge and acquisition of technological tools the poorest part of the population have. Furthermore, achieving stable economies can be used to promote investment from different MFIs which could in turn potentially lead to sustained economic growth while also reducing the wealth gap within Latin American countries.

Going hand-in-hand with the economic programs just discussed, ecologically-conscious economic models could be a key component of how an eventual ‘start over’ could be accomplished in the region to overcome the economic crisis. With climatic conditions rapidly deteriorating due to sustained pollution and exploitation of natural resources, ‘starting again’ the economy would mean to preserve this environmental destruction, with polluting factories, crowded cities, and contaminating transportation depleting natural resources. In the long-term, this will generate the deterioration of the health of Latin Americans, and the reliance on exploiting limited natural resources could unravel into a new economic crisis when these resources expire or when the developed world stops consuming them, replacing them for renewable sources of energy. Therefore, taking a step ahead and implementing new economic models which promote sustainable economic growth could be a crucial measure to catapult the region into a new and prosperous era.

To what extent latinoamerican countries can reset their economies?

In the last decades many regional leaders have had the tendency to use national funds and the investments from private entities improperly, not only filling their own pockets but also superficially covering all the cracks of the ineffective-old system which should be cut from the root. Consequently, economists have developed new economic models in order to fix the drawbacks caused by the previous ineffectual ones. However, it must be acknowledged that these latest propositions are more challenging to apply in developing countries than in those already developed.

Three years ago, the economist Kate Raworth proposed a way to take the global economy into the 21st century with her “Doughnut” Economic model. It depicted the social and planetary boundaries we are facing and how we should deal with the challenges they present. She explains that the Doughnut’s centre reveals the proportions of global citizens that are falling short on life’s essentials, representing the challenge to get everyone out of that hole. But, in the process of achieving that, if we want to safe-guard Earth life-giving systems we can’t afford surpassing the Doughnut’s outer crust, so in many situations leaders will deal with a conflict of interests which makes decision-making even more demanding.

She suggests that in order to transform today’s divisive economies, we need to create new ones that have a distributive design. To do so, countries should take full advantage of network technologies and, by stopping redistribution policies, largely focus on income. Countries should concentrate their attention on making policies relating to the sources of wealth that generate income instead (such as the wealth that comes from controlling land, resources, money creation, etc.)

When we talk about the Doughnut model it is clear that the more economic power a country has, the more likely it would be to apply it and benefit from doing so promptly. As previously mentioned, Latin American nations are not characterized for being economically stable, so putting this model into practice is very complex as it can easily backfire.

On several occasions, the main economic source of income of a developing country comes from the performance of an activity that generates a high-level ecological footprint. Cutting its production will result in a reduction of the nation’s wellness, raising unemployment and incrementing social inequalities. Most of Latin American countries have a dependence on such kind of activities, some examples evidencing that are: Venezuela’s, Ecuador’s, Bolivia’s, Mexico’s and Colombia’s reliance on hydrocarbons such as oil and gas, and Argentina’s dependency on the production of meat (as the world leading exporter). Activities that not only release CFC, O3, and more gases that severely affect the ozone layer but that also require deforestation of the main source that counterattacks the negative impact of those gases, the trees.

According to Florencia Tuchin “The area of the Amazon Rainforest that has been destroyed is equivalent to 1.4 million soccer fields” (2020, Compromiso Empresarial). This number makes us question ourselves if there is a way to reduce the ecological footprint of the region without diminishing its population’s living-conditions (which are already not fully proper for all). We cannot ignore the fact that if Latin America and the rest of the world do not protect the Earth now all their actions will boomerang in the future. Eventually, if we do not stop global warming, the region’s agricultural and cattle raising production will not provide as it is currently providing, making this a concerning issue.

Since the pandemic was declared, plenty of new economic theories based on the world economy are suggesting that nations should use their resources in order to create a new system that would be more resilient, equitable, and sustainable in the long run. Regardless of the fact that Rateworth never saw a pandemic coming when she wrote her analysis, many of these latest theories are inspired by her thinking.

Despite the sharp economic downturn we are facing, there are many professionals who consider that if we act quickly and jointly, we can emerge from this crisis a better world. Klaus Schwab, Founder and Executive Chairman of the World Economic Forum, argues that the changes we have already seen in response to COVID-19 prove that a reset of our economic and social foundations is possible.

This optimistic view states that in order to avoid world economies facing an outcome worse than the depression of the 1930s, a “Great Reset” of capitalism is needed. This will involve all countries and industries acting “jointly and swiftly” to reconstruct all aspects of societies and economies. It is a fact that the current situation will exacerbate the climate and social crises that were already underway. Unfortunately, many countries instead of acting cooperatively with its own citizens and with the international community, have used the coronavirus crisis as an excuse to weaken environmental protections and enforcement, frustrations over social ills like rising inequality, etc. Proceeding in this way will deepen all the hassles and leave the world even “less sustainable, less equal, and more fragile”.

It is important to be aware that incremental measures and ad hoc fixes will not be sufficient to prevent the depression; our economic and social systems foundations must be redesigned completely. In the past few months there is evidence that this is not an impossible dream, and that the will to build a better society does exist. Populations have shown a willingness to make sacrifices for the sake of health-care and the elderly. Also, companies have stepped up to support their workers, customers, and local communities. The Great Reset will rely on this willingness to help and will require stronger and more effective governments, and will demand the private-sector to engage in its enforcement.

Its agenda would have three main components. The first would steer the market toward fairer outcomes, this will require governments: improving coordination, upgrading trade arrangements, creating the conditions for a “stakeholder economy”, and implementing long-overdue reforms that promote more equitable outcomes (e.g. changes to wealth taxes and withdrawal of fossil-fuel subsidies). The second would ensure that investments advance shared goals, such as equality and sustainability. And, the third would harness the innovations of the Fourth Industrial Revolution in order to support public good.

But you must be asking yourself: is the region truly able to enforce these components? We do not want to be pessimistic and answer with a direct no, nonetheless we must be aware that Latin American countries deal with more challenges than the rest of the international community for doing so.

The first component suggests implementing long-overdue reforms such as withdrawing of fossil-fuel subsidies, and it was just last year’s final quarter when the Ecuadorian president Lenin Moreno tried to do so in the country, resulting in protests that paralized the nation until the head of state repealed the law ending fuel subsidies. The second component encourages investments for shared goals, but how can these be achieved if corruption in the region is skyrocketing? Many Latin American political leaders are notorious for using their power to fill up their own pockets instead of looking for their people’s best interests. Finally, the third component relies on the Fourth Industrial Revolution which is based on new technologies that reduce the ecological footprint and accelerate the production and communication process. These investments would only be possible if the previously discussed targets of reducing political corruption and public sector inefficiency are achieved.

So, shall Latin American countries start again or start over...?

Evidently, the economic and social impact caused by COVID-19 will usher long-lasting variations which will permanently change how society operates and influence the decision-making of Latin American governments in the following years.

In order to tackle the challenges that the virus presents, the region will need to count with as much capital as possible to promote its recovery, so its fight towards corruption and bureaucracy must continue. As these are pests which cannot be eliminated overnight, the region has to embrace more alternatives to be able to face this crisis steadily.

Seeking not only short-term economic recovery, but long-term growth, would be a decisive step towards steering the region’s future to a more stable and egalitarian one. Promoting schemes such as microfinancing, complemented with financial and technological education for the population, hold the potential of pulling millions out of poverty. Projects of the sort, which could provide jobs and expanding, more inclusive private sectors, would ideally keep more Latin American children in school and would increase tax collection in the long-run. Aiding this cycle could thus mean further investment in education, health, and security, and diminish the entrance of poor people to criminal organizations. As explained thoroughly, the effectiveness of these schemes in changing Latin American society substantially will also depend on countries’ willingness to embrace State efficiency and keep political corruption in check.

Instead of implementing redistribution plans that halt productivity and growth, Latin American countries should focus on making policies relating to the sources of wealth that generate income which steer the market towards fairer outcomes, assuring more effectiveness. Also, the region should be aware that exploiting its natural resources is a strategy that as the years pass, the more possible it is that it will backfire. So, LAC should take the restructuring process as an opportunity to practice new economic models that would be environmentally-friendly to properly protect its main source of income (raw materials). Furthermore, the region should invest in network technologies in order to benefit from a full advantage of what they offer, diminishing the huge digital divide its population is experiencing, and reducing the dependence on natural resources.

Written by Adrián Fernandez and Alexia Hansen-Holm.

Both authors are members of RETHINKING ECONOMICS, a Bocconi student association.

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