Latin America: The Second Stage of Reform

At the end of this century, in Latin America—as almost everywhere in the world—few institutions are held in more disrepute than the state. The state is widely perceived as too incompetent, too corrupt, or too crippled by political restrictions to be a reliable or effective instrument for achieving collective objectives. Hence the turn to the market.

Discovering the market and abandoning overreliance on the state has done wonders for Latin America. In the 1980s, average inflation for the region was more than 150 percent per year; as recently as 1990, prices were rising by 1,200 percent annually. By 1993, inflation had plummeted to 19 percent, and economies that had shrunk every year for more than a decade had reestablished patterns of growth.¹ While average growth in the region is not high, some countries, such as Chile and Argentina, achieved growth rates that in some years put them on a par with the economic powerhouses of East Asia. A region where, for years, any excess funds instantly became flight capital is now a powerful magnet for international investment.

But the discovery of the market will soon force Latin American countries to rediscover the state. Sustaining and deepening the positive changes brought about by the turn to the market will require states to increase their technical and managerial capacities far beyond present levels. In most countries of the region, even those that have advanced farthest in the adoption of market reforms, the state continues to perform functions better suited for the private sector while exhibiting an appalling incompetence in discharging core public functions. The process of dismantling the state and limiting its scope of intervention is still far from finished. At the same time, however, the more difficult task of creating or rehabilitating indispensable public-sector institutions lags far behind the requirements of both the new economic strategy and the political imperatives imposed by Latin America's feeble democracies.² While the region's political instability may be attributed to a variety of causes, it has been exacerbated in recent years by the inability of the state to deliver basic public services. Together with the social effects of high inflation and unemployment, the acute deterioration of state capacity has become a powerful destabilizing force.

The biggest threats to economic stability—a relapse into fiscal disarray and insufficient international competitiveness—also flow from the failure to improve the performance of existing public institutions and policies. Sluggishness in creating new public agencies that are critical for the functioning of an open, market-based economy is undermining economic performance. Moreover, unless the administrative capacity of Latin American governments is increased, social conditions are bound to deteriorate, regardless of how much money is poured into social programs. Bringing the state back in ways that support and reinforce recent progress—without restoring the state's previously displayed penchant for inflicting economic, social, and moral havoc—will be the central challenge facing governments throughout the region.

The spectacular turnaround that Latin America has witnessed so far did not hinge on the performance of public agencies. Rather, executive orders altering the macroeconomic environment did most of the work. That stage is over. Most countries are now entering a new stage in which they must respond to different priorities under political, institutional, and international circumstances that differ markedly from those characterizing the period when market reforms were launched.

Stages of Economic Liberalization

The region's recent progress was achieved by shrinking the state and rejecting economic policies that depended on the discretionary decisions of poorly trained bureaucrats accountable only to the political bosses who controlled their badly paid (but highly profitable) jobs. Countries dismantled some of the most pernicious public institutions. Agencies in charge of policing compliance with thousands of officially set prices, of administering foreign-exchange controls and trade quotas, and of screening and authorizing foreign investment projects were done away with. Entire divisions within ministries were idled by the new policies. The adoption of a stern fiscal discipline to reduce the swelling of public budgets, the widespread deregulation of trade and investment, and the privatization of some money-losing...