Abstract

This paper discusses stabilization programs in Latin America, with an analysis of the general conceptual framework and of a few practical experiences that demonstrate the main points. The viewpoint will be that of a policymaker, with an emphasis on those issues that experience has generally shown to be the most controversial.

This paper discusses stabilization programs in Latin America, with an analysis of the general conceptual framework and of a few practical experiences that demonstrate the main points. The viewpoint will be that of a policymaker, with an emphasis on those issues that experience has generally shown to be the most controversial.

The paper begins by discussing why governments try hard to attain stability and then defines stability and focuses on what is required, and the instruments typically used, to achieve it. Next, it examines institutional difficulties or pre-existing problems, the real scope of which can be assessed only in a climate of stability. The conceptual discussion concludes with a presentation of a few problems that recently arose in connection with stabilization plans that have otherwise been very successful. Finally, comparisons are made between experiences in Argentina, Chile, Mexico, and Uruguay. Given the brevity of this paper, remarks on each topic are confined to the most salient points.

Objectives of a Stabilization Program

Short-term programs typically involve three competing objectives: general price stability, the economic growth rate, and balance of payments equilibrium. Stabilization plans normally focus primarily on the general level of prices. However, it is recognized that price stability cannot be achieved during a prolonged recession or in a situation of external imbalance. To some extent, stability depends on whether economic activity realizes its long-term potential and on the expectation that the external accounts will require no drastic adjustments.

The demand for financial assets—money, bonds, or deposits—depends on the viability of the current situation. To a large extent, for stabilization programs to succeed, capital markets must operate normally, and that goal can be extremely difficult to achieve without a coherent short-term policy. In the context of stabilization, it is important to recognize that inflation is a monetary phenomenon in the strict sense: to measure it, one must use monetary concepts. This view is not an attempt to reopen an old Latin American debate between structuralists and monetarists in that it does not take a position regarding the causes of inflation: whether it is due to an initial monetary imbalance; cost pressures, external shocks, and relative price rigidities; or indexation phenomena. The statement refers exclusively to the fact that continuous changes in the monetary base are required to convert a rise in prices into an inflationary process.

The second major issue is to recognize inflation as a form of taxation. When a tax increases for an individual, to a large extent it increases the government’s net wealth. As the definition implies, a deficit position in the current sense is not required; what is required is a disequilibrium that is financed by the issuance of money. Thus, for example, an inflation tax can be used to reduce domestic or external debt or to accumulate reserves or claims on the private sector through loans. The increased government wealth will imply less need for taxation in the future. The monetary and fiscal characterization of inflation must then refer to the need to create a new system in both areas if stabilization is to be achieved.

Reasons for Stabilizing

The launching of stabilization plans has generally provoked opposition from some social groups because of the adjustment the plans imply. For example, experience shows that they sometimes generate declines in the level of activity and in real wages and a rise in real interest rates. However, in spite of opposition, governments make bold efforts to overcome high inflation and should be strongly supported. They are motivated by a number of considerations.

First, comparisons are usually made between the stabilization period and previous periods. This methodology is inappropriate. The correct comparison would be one based on an estimation of what might have happened had stabilization not been attempted. Considering the destructive effect of hyperinflation on the level of activity, real wages, and investment inflation in Argentina, Bolivia, Nicaragua, and Peru, there is no need for lengthy argument.

Second, the high inflation rates experienced by Latin American countries have decreased the efficiency of the price system in allocating resources because the rise in the variability of relative prices makes them less reliable as a source of information and a greater source of risk. In turn, the loss of nominality makes past prices irrelevant for establishing contrasts, and a vital factor in domestic competition is lost. This clouding of the data caused by inflation has created quasi-monopolistic factors in markets that, by their nature, should be highly competitive.

Third, mega-inflation destroys the various functions of the local currency (unit of account, store of value, and transaction facility), resulting, at best, in its replacement by a foreign currency for which the economy must surrender resources (without remuneration) and, at worst, in episodes of hyperinflation that block transactions (as occurred in Argentina when sales were suspended). The severe demonetization causes a loss of resources and creates hardships: unending lines at banks and time and effort wasted in arbitration, re-marking prices, and preparing budgets.

Fourth, the sharp regressiveness of the inflation tax is noteworthy. There is no need to stress the inequity of access to anti-inflationary coverage or the disproportionate impact of inflation on monetary reserves for transactions, which make up a greater portion of the net worth of the poorest social sectors compared with other social sectors. The inequity of the inflationary tax also has a negative effect on the social climate and discourages productive efforts.

Fifth, inflation decreases the effectiveness of the tax system, particularly of those taxes that are more distinctly progressive, thus worsening the situation described above.

Sixth, the most affected markets are those having to do with growth, such as the investment, capital, and financing markets. Owing to price volatility, the breakdown of financial intermediation, and the loss of relevance of accounting statements and economic information, growth possibilities dry up. This outcome increases discouragement and fosters pessimism.

Finally, using inflation as a tax not established by law gives a sense of illegitimacy to all government activities. Ultimately, the authorities are induced to confront the upsurge of inflation by launching stabilization programs, in spite of all the difficulties and institutional reluctance.

Stabilization Program Requirements

The closing of the fiscal gap is the first component of any stabilization program. For the closing of the fiscal gap to be effective, it must be permanent; if temporary measures are used, they will not generate the credibility required and will be an obstacle to the forces cooperating to build the stabilization pyramid (rapid monetization, a decline in interest rates, and greater financing that will make the economic recovery possible). Because stabilization plans in Latin America used fiscal measures that were temporary, a number of the stabilization attempts were short-lived, which, to a large extent, explained their failure in spite of the fact that they were initially conceived with great technical virtuosity (for example, Argentina’s Plan Austral). Generally, the fiscal gap to be closed is of a recurrent nature and must be addressed with resources that are similarly recurrent.

Second, nominality must be re-created; that is, a nominal magnitude must be set that is invariable whatever the trends in the other economic variables. In other words, the other variables should not cause the nominal magnitude to change. The nominal anchor can take various forms. Generally, there is a tendency to choose a variable that is clearly under the control of the monetary authorities, for example, the money supply and the exchange rate. The chosen variable and the rate at which it is altered must be essentially sustainable. Sustainability is determined to a large extent by the fiscal position and compatibility with other nominal policies. For example, setting an anchor that implies excessive real interest rates would be far from suitable.

In most stabilization processes, the preference has generally been for a fixed exchange rate because the lengthy inflation process and the high level of currency substitution make it difficult to use a monetary target as a primary gauge. Monetization can give rise to a very strong real appreciation, with serious consequences for competing sectors because of the high interest rates implied. A fixed exchange rate makes it possible for economic agents to establish internally the desired level of the local currency and, thus, to avoid excessive flexibility in general price levels, with the difficulty that this implies for wages and nominal government expenditure.

It is extremely important to note that levels fixed for other nominal variables, as well as their rate of change, must be compatible with the chosen anchor. Two numbers are vital: total government expenditure and the nominal wage. It is difficult to believe that the fixing of the anchor is sustainable when nominal changes in these variables are well above international inflation and the increase in productivity (generally, failure has been related to this problem). Careful attention should also be paid to the initial level because financing through high taxation of (sunk) investment is not enough. There must be profits and investment possibilities with the rates of taxation established.

A point that is often underestimated is that the stabilizing adjustment process is usually accompanied by a need to correct any strong external disequilibrium caused by an excess of absorption. The most contractionary phase of adjustment is generally due to this problem. Inflation, especially mega-inflation and hyperinflation, can destroy economic activity. Its reduction should therefore result in economic recovery (this was very obvious in Argentina).

According to the recent literature, stabilization processes are usually accompanied, in their initial phases, by a fall in real wages and a rise in the real interest rate. With respect to the former, a distinction must be made between purchasing power and real wages in an environment of mega-inflation, since at such inflation rates, the deterioration that occurs between the time wages are earned and the point at which they are actually received is substantial. Consequently, the normal decline resulting from a fall in wages because of a slowdown in the growth of nominal expenditure compared with the prices implicit in aggregate supply must be adjusted with the latter statistical component.

It is noteworthy that the interest rate effect will be all the more significant when credibility is low. Here, the distinction between ex post and ex ante is highly relevant. A slowdown in inflation generally occurs sooner than expected, thereby causing such high rates. This factor is very important if domestic debt is high. One of the reasons for the relatively smaller adjustment in Argentina is that the hyperinflationary process practically eliminated domestic debt. This outcome influenced the Plan Austral, Primavera, and President Carlos Menem’s first stabilization attempt, and, in turn, the Chilean and Mexican plans.

Designing the Plan

Stabilization plans are generally constructed on the basis of policies formulated to control aggregate demand. In this way, the rate of growth of nominal expenditure is reduced in an attempt to bring it closer to the rate of growth of real output.

Supply and Demand Policies

To a large extent, emphasis is placed on demand policies because it is easier to quantify them and to set targets and controls for them. They are more readily perceived by the public, the specialized press, and the international agencies that normally support the policies. Commitments are relatively simple to establish when they involve quantifiable targets, and this is indispensable when conditionality motivates domestic and external agents, such as when debt must be restructured at the same time.

However, supply policies have recently begun to acquire more importance. Naturally, no one thinks that inflation at three digits or more can be corrected with increased production. Supply policies are popular for other reasons. The persistence of high inflation and poor economic organization were generating a profound distortion and an inflexibility that, if not removed, could substantially increase the cost of stabilization. Supply polices include the following:

(1) Flexibility of factor mobility and prices. To adapt to the new demand structure, flexibility is essential in matters of employment (contracting, maintenance, functional versatility, and terms of labor contracts), availability of capital, and rights to capital. The delays caused by commercial (company) and bankruptcy laws that prevent the rapid restructuring of production are often underestimated.

(2) Elimination of distortions. The barely competitive and strongly subsidized behavior of a closed and highly inflationary economy implies that there is less potential for activity and adaptation, both of which are enhanced by stability. If this effect is not corrected, the capacity to adapt to the new demand structure is minimal, and the underutilization of resources that the slowdown in nominal expenditure growth suggests is likely to be exaggerated.

(3) Protection. One of the mechanisms most often used to obtain flexibility, competition, and financial resources is to transfer to the state resources that benefited some sectors in the private area through excessive protection. The reduction in protection enables the economy to change the production structure, through a low and standard tariff, to one that is more adaptable to domestic and external demand. This makes it possible to reallocate resources rapidly when the level of domestic absorption changes. In the small economies of the region, this reform may well be the most complementary to the stabilization process. Even in the larger economies, it contributes greatly to the design and control of stabilization programs by imposing considerable self-discipline. It should be remembered that, following many years of disorder and inflation, no one knows what relative prices are appropriate.

(4) Inertia and deindexation. In the literature, this is perhaps one of the most analyzed supply policy components. Correcting the structure of contracts is unavoidable and is now generally accepted. Breaking with the past is an absolute must if stabilization is to be successful. Moreover, the existence of constitutional requirements for backward indexation perhaps explains why Uruguay is not successful in reducing its inflation rate to international levels, in spite of its reasonable fiscal and monetary situation.

(5) Incomes policies. These are generally placed under the same heading as inertia although some think they are a different matter. Incomes policies involve coordinating trends in wages and in controlled or regulated prices from the start of stabilization. There is always an incomes policy, whether it is explicit or implicit. The key is to acknowledge that such a policy seeks to avoid repeated attempts to achieve macroeconomic equilibrium with a high cost in terms of economic downturn. It cannot be claimed that these policies are effective at income distribution. In the final analysis, this objective falls in the domain of fiscal policy. The compatibility of an incomes policy with an exchange policy is perhaps the major test of the viability of the stabilizing adjustment.

(6) Reorganization. A critical feature of recent stabilization programs in Latin America has been a dynamic reorganization of the institutional and administrative structures. Privatization, with three important elements, must be understood in this context of new regulation: (a) less manipulation of prices and subsidies in the future and, therefore, a lower deficit; (b) the expectation that there will be a set of actors who will feel keenly committed to stability and its success; and (c) the possibility of using resources from sales to bridge the fiscal gap in the short term or to settle the external and internal debt, for example, in Argentina.

An essential aspect of stabilization is credibility, which is difficult to define and quantify. Credibility is not easily gained, and, like a reputation, can be lost in a moment. It is well known that both individuals and communities find attempts at stabilization hard to believe, particularly following various failures in that area. Evidence shows that credibility is based on the consistency and internal logic of the program; the character, reputation, and cohesion of the technical team appointed; and political support that is expressed both in word and in deed.

These characteristics can be demonstrated by consistency between announcements and actual practice and the viability of measures suggested at the technical level in terms of instrumental feasibility and political support. Initially, the reorganization program will be tested and challenged. There should be no doubt about its irreversibility. Another criterion for credibility is the transparency of data. When in doubt, those with the most liquid funds are naturally extremely fearful and expect failure. A lack of transparency is the enemy of success in stabilization. Any effort that provides as much information as possible, with the widest coverage possible, will enhance credibility.

A Few Basic Requirements

It has already been pointed out above that when inflationary crisis lasts for many years, it is difficult to have a notion of what is normal. Generally, a workable solution to such a crisis is to think of the program targets expressed in foreign currency. First, this provides a simple mechanism to correct for inflation that makes it possible to standardize data for different periods; second, it reflects a recognition of the role of government expenditure as an input in the productive process and the viability that this expenditure must have in an open economy (financing cannot be provided for an unlimited level of government expenditure).

Once expenditure and revenue have been calculated at the appropriate rate of exchange, the net revenue from the elimination of subsidies and quantitative trade restrictions, the generalization of the tax bases, and the equalization of rates should be incorporated. This exercise should make it possible to close the fiscal gap. If this is not possible, a different ratio of wages to the exchange rate should be used.

Once the fiscal gap has been closed (ratio of wages to exchange rate and taxes), the nominal problem, that is, the ratio of base money to external reserves, should be addressed. Generally, a low initial ratio (high reserve levels) at the beginning averts the need for a traumatic initial jump in taxes. The initial high inflation tax generally makes it possible to enjoy a lower interest rate and less vulnerability to capital flows. Even though building up greater reserves by means of a significant fiscal effort eases the initial trauma of the correction, it leads to continued uncertainty and high domestic interest rates that conspire against closing the fiscal gap if there is domestic debt and against improving the level of activity and tax collection if the debt is marginal. The initial trauma can be considerable if, in addition, the real adjustment required to close the fiscal deficit is significant. At any rate, these principles will depend on each country’s actual situation and previous monetary history.

Following the initial effort and once the lack of transparency created by inflation has been corrected, a highly complex development in stabilization experiences is a particularly disagreeable reality that, in some cases, can be clearly perceived. For example, the low real wages that are part and parcel of undercapitalized, inefficient economies, the lack of competitiveness of domestic activity, and the problems of extreme poverty become highly visible and generate needs that are generally incompatible with macroeconomic discipline. In this perspective, regional and social disequilibria must be evaluated and a program developed to deal with them, so as to avoid creating conflict between the stabilization effort and social needs.

Another factor, which is positive but may create new problems that will be discussed in detail later, must be included in any contingency plan. This factor is the return of capital, which exerts very delicate pressure on relative prices. In this sense, tight fiscal policy and careful control of domestic credit expansion are vital.

Institutional Difficulties

The requirements described above generally relate to an economy with a simplified, timeless institutional structure. In practice, institutional setup and history make the design of stabilization programs much more complex. Three aspects of this problem will be discussed.

(1) Countries with a federal system. In federal countries, there are generally three levels of government (federal, provincial, and local). Among these levels of government, some transfers are related to tax collection, and disequilibria at the lower levels of government have repercussions at the federal level and for the monetary authority. In principle, a well-designed federal organization gives macroeconomic responsibility to the central government, so that transfers to state and local governments and their debt policies are not linked to the economic cycle. In practice, a large part of the adjustment to be carried out involves precisely this task. If transfers are linked to tax collection and if the behavior of tax bases is also cyclical, it is highly likely that a large portion of the effort to increase revenue will be diluted in this filtering process.

This type of difficulty could create the temptation to design faulty instruments with the objective of avoiding the problem of federalism. To some extent, correcting this malfunction is vital for the orderly management of the macroeconomic question. In particular, expenditure decisions should be decentralized as much as possible, so as to implement the principle of fiscal responsibility to the maximum. (Each marginal expenditure decided upon must be financed by the local community receiving it.) This would make it possible to establish a relationship between the availability of tax resources and the level of spending.

(2) Social security. In the midst of the inflationary crisis, one of the sectors in which expenditure must be adjusted is the social security system, where payment arrears, retirement postponements, and actuarial nonviability accumulate. Once prices have been stabilized, this problem rises brutally to the surface, and, because of the magnitude of the problem, fiscal balance can become impossible to maintain. Consider, for example, that in Uruguay the system’s actuarial disequilibrium was calculated at 200 percent of GDP (in some European countries it is in excess of this figure). The dimension of this problem goes beyond the normal problem of government indebtedness.

A program to deal with social security is crucial, above all because social security diminishes the aggregate savings that are vital for the modernization of the economy and for solving employment problems. The potential solution should avoid high rates of taxation on those individuals who will receive no return on these services and should maintain the definition of actuarially viable rights. It is vital to restore the legal rights of all participants in the social security system, but to accept the budgetary restrictions (between crisis periods) if an economic recovery is to be achieved and a loss of confidence in the stabilization plan is to be avoided. In particular, institutional arrangements should not accommodate the use of implicit debt.

(3) External debt overhang. The existence of government debt that is disproportionate to output and exports, with a market value well below its face value and a significant accumulation of arrears or constant renegotiations, can become a major obstacle to the design of a program to achieve stabilization and revive investment. In practice, the interest rate implicit in such government debt renders investment nonviable. Stabilization plans have therefore generally been accompanied by a major external debt-restructuring program, which both clears the fiscal horizon and reveals the implicit cost of investment. External debt arrangements must be complete and the domestic effort consolidated.

The cooperation of multilateral agencies and of official agencies in industrial countries is generally required for a solution to be found, implying a program of conditional assistance that will provide an additional guarantee for capital flows. This is vital to the credibility of the program and to the recovery of the credit rating required to finance investment and expand trade.

A Few Recent Problems

The above sections provide a broad overview of stabilization programs that reflects, to a large extent, the experience of the 1980s and early 1990s. It is also useful to highlight a few recent problems that individual countries have experienced with their stabilization programs, which they developed in specific external circumstances. These experiences will greatly influence future developments in the region.

(1) Currency overvaluation. Considerable currency overvaluation has been a common feature in Latin American countries and stabilization programs and will be referred to in the examination of individual experiences. According to local authorities, currency overvaluation represents the strong recovery of confidence, owing to the aptness and pertinence of the plans used. An alternative explanation is that worldwide circumstances and the over-indebtedness of the industrial economies have produced a disinclination on the part of solvent individuals to borrow, which in turn has generated an abundance of available resources that have caused the collapse of interest rates worldwide. This not only dramatically facilitated the Latin American adjustment (one would have to see how many Brady Plans could have been possible at the interest rates prevailing in the 1980s), but also made investment in the paper issued by many countries extremely attractive.

This exceptional process, which was lucidly described by Calvo, Leiderman, and Reinhart, 1 generated high capital inflows that, in countries with strong protectionist policies and limited capacity to absorb such flows, resulted simultaneously in considerable overvaluation and slow growth in the current account deficit. If there were no substantial protectionist structure, the problem of capital inflows would be less relevant, first, because the exchange lag experienced would not exist, and, second, because the level of domestic activity would not depend exclusively on domestic absorption. Goods produced by local producers could be exported without difficulty to the rest of the world, which the protectionist structure in some of these countries does not permit.

There is speculation on the direct impact the reduction of capital flows and the raising of interest rates will have on public sector expenditure.

However, the major problem will be the considerable restructuring of aggregate demand, and its consequences (for government revenue) will be the major difficulty. It must be borne in mind that domestic tax collection is generally structured on the basis of domestic absorption, and industrial activity encounters serious difficulties in reorienting its production in world markets.

(2) Low aggregate savings. Stabilization programs have been accompanied by changes in the composition of external savings flows and a structural weakening of domestic savings. Various hypotheses can be tested to explain what occurred. First, the falling inflation tax, which had mainly affected the low-income sectors and those with the greatest propensity for consumption, was replaced by taxes that affected the population’s capacity to save, which had an impact on the overall savings ratio (taxation of households was transferred to the enterprises).

The second, temporary feature of hyperinflation was that consumption was massively postponed in favor of increasing private claims against the rest of the world. When the return to normalcy was felt, these emergency provisions began to decline; excessive consumption is probably a temporary aspect of the process. One result of this effect is that a significant portion of external government debt was owned by citizens of the countries in default for whom the recovery then produced a windfall, owing to a revaluation of their securities.

The third possible explanation is that there was a fall in the relative price of capital goods, while real volume did not decline. This can be appreciated from comparisons of capital goods at current prices and at constant prices and from the substantial rise in the cost of services compared with goods (services are very labor intensive).

The fourth factor, also applicable to a number of cases, is the strong rise in social security transfers that, by their nature, lead to a major increase in the propensity for aggregate consumption. In Argentina, this was aggravated by the settlement of a significant amount of payment arrears financed through the sale of government capital goods.

(3) Financial problem. The strong expansion of financial markets that accompanied the stabilization programs and a significant growth in private indebtedness at extraordinarily high interest rates are cause for concern in the future. It is clear that the share of private debt in GDP is minimal and that previous experiences have led economic agents to be extremely cautious. Reforms of the financial system’s regulatory framework and the experience of international banking and capital markets has led to more prudent risk assessment than in the recent past.

However, given the rate of growth of financing, and especially its high cost, a note of warning is warranted. The possibility of distress borrowing by official banks or an inadequate level of provisioning in private banks is a matter that should receive policymakers’ most careful attention. To some extent, assiduous implementation of the Basle recommendations may alleviate this problem. One unavoidable question is why economic agents assumed debt at exceptionally high rates. One reason may have been the lack of credibility of the ongoing program; another, the high profits generated in the consumption boom that came with stabilization; and, finally and most important, that in spite of their high cost, these rates reveal a dramatic decline in the cost of capital compared with the cost borne during periods of mega-inflation and capital flight.

Whatever the case, the emergence of rating agencies, their rating of risk, an unprecedented research effort, and greater attention to regulation should prevent a recurrence of the disregard for principles seen in the 1980s, which was at the bottom of the failure of stabilization plans in the financial sectors.

Comparative Experiences

Argentina

For Argentina, it is important to provide the historical background because most adults have no memory of a period of prolonged stability. Demonetization had reached extremely low levels in 1988–90, and currency substitution had made it normal for the most elementary transactions to be performed in foreign currency. The losses incurred by economic agents operating in pesos had reached magnitudes for which it is difficult to find comparable figures in other countries.

It was in this context that the Argentine authorities launched the convertibility plan in March 1991, which involved essentially fixing the exchange rate by law (the capacity to devalue by surprise was thus lost), and establishing full currency backing (convertibility into foreign currencies and into bonds in foreign currencies valued at market prices). Thus, funds could be provided neither to the nonfinancial public sector nor to the banking system, which had, in the past, received enormous transfers from the Central Bank of Argentina.

In practice, convertibility meant abandoning two influential instruments of the past: the inflation tax and exchange policy flexibility. This move implied, for the future, fiscal equilibrium or noninflationary financing of the disequilibrium—which amounts to almost the same thing (over time, a difference could emerge between the two)—as well as an absence of the massive rediscounts that were used intensively to ease financial crises in the past. With respect to flexibility, it became mandatory, in the face of any external shock, for domestic prices and wages to be adjusted in the manner of the gold standard. The crucial point was that the monetary anchor determined the fiscal side and that the political authority was to make the necessary adjustments to implement convertibility.

This change was possible because, among other reasons, the crisis had become so acute that it was possible to remove most institutional restrictions and overcome the antireform coalitions of the past. Stabilization was accompanied by a dramatic economic restructuring that affected the country’s integration into the world economy, government ownership, financing, and all aspects of economic organization. Briefly, the convertibility plan comprised the following main reforms and restructuring measures:

(1) The federal issue. Unlike past stabilization programs, the fiscal deficit was now to be eliminated using traditional taxes (by widening the base, removing exemptions, and applying the withholding procedure generally), with an emphasis on reducing evasion and improving tax administration.

The difficulty of this strategy was that the national treasury received only 42 percent of the increased collections, while the rest went to the provinces under the revenue-sharing mechanism, and at the same time expenditure increased. This explains why past stabilization plans used export taxes and surcharges on government fees, which cannot be legally transferred to the provinces. The mechanism used to solve this problem was to transfer federal spending obligations, through subsequent laws, to the provinces and to allocate resources from the revenue-sharing fund to finance the social security system. This procedure made it possible to overcome a serious institutional limitation. Its implementation reveals, in addition to exceptional transparency, enormous political power (the government party controlled two-thirds of the senate).

(2) Outstanding debt. Three elements deserve special attention:

•External payments. Argentina had, for all intents and purposes, been in arrears with its external payments since 1982 and ceased payments totally to private banks in April 1988, although it began to make small payments (a fraction of interest) in June 1990. Considerable external payments arrears—more than $8 billion—accumulated. This problem was resolved within the framework of the Brady Plan and involved the cooperation of the multilateral agencies, the Paris Club, and Japanese financial institutions. Agreement was reached after considerable control of the inflationary and fiscal situation had been achieved and after IMF support had been received under an extended Fund facility arrangement. Success in this area consolidated and strengthened favorable expectations. In particular, it facilitated a clear definition of the sacrifice to be made by the country in the future and how best to take advantage of any additional effort that might be made.

•Domestic debt. In the hyperinflationary process, the first item that ceased to be paid was Argentina’s entire debt to suppliers, along with tax subsidies and tax refunds on exports. This debt was consolidated in March 1991 and refinanced over 16 years in the form of consolidation bonds that paid no interest or debt service for a long period (grace period). Another portion of the debt was refinanced with banks, also for a medium term. To a large extent, this approach worked like forced financing that placed extreme restrictions on expenditure, at least until the debt became liquid (that is, paper was issued). In the Argentine fiscal accounts, many of these outlays are not included in the yearly expenditure flows. In other words, changes in the debt are not taken into consideration in deficit measurements (this being especially significant for social security).

•Social security. The program had three types of problems to deal with. First, social security benefits paid out were lower than established by law, causing an accumulation of debts and legal claims. The debts calculated under this heading reached some $7 billion in March 1991. Second, new debts were falling due because of the system’s actuarial imbalance; this situation worsened from year to year. The first and second issues were resolved with two debt consolidations, under which retired persons were paid in ten-year bonds resolved with six years of grace, covering the debt accumulated as of March 1991 and at a fraction of revenue-shared collections. In addition, the system was capitalized with a portion of government shares from the sale of public enterprises and part of the tax on profits, which should make it possible to settle pending lawsuits. Third, a social security reform provided for the actuarial debt to be eliminated upon achievement of steady state, making it possible to meet social security commitments without the need for exorbitant payroll contributions.

Among the crucial reforms carried out by the Argentine government were normalization of the tax situation, a change in the budgetary structure, social security reform, the settlement of domestic and external debt, the creation of a new regulatory framework, and privatization.

A surprising feature in Argentina’s stabilization effort, compared with that of other countries, is the low public sector primary surplus. This is due, above all, to the fact that the lengthy inflationary and hyperinflationary experience practically eliminated domestic indebtedness. In addition, the external debt is not significant in GDP terms, although it is more so in relation to exports. This low primary surplus was not, in any case, neutral. To a large extent, it explains the substantial overvaluation of the local currency. If the settlement of the social security debt is included as an expenditure, there is no primary surplus. This, in turn, explains the persistence of high spreads on debt in international securities although net capital inflows exceeded exports for more than two consecutive years. The tasks that remain to be accomplished in terms of productive restructuring and opening up the economy are still considerable, and it is perhaps in these areas that the weakest point of the plan is found.

The quantitative data with respect to both Argentina’s experience and that of other countries are provided in the appendix tables to illustrate some of the comments made.

Chile

Chile figured for a very long time among the high-inflation countries of Latin America. Indeed, on the basis of Chile’s experience, the first discussions were held in that country between monetarists and structuralists. Chile’s history of high inflation, with hyperinflationary characteristics, erupted during the government of Salvador Allende, when the deficit finally reached almost 30 percent of GDP, and the disequilibria generated a supply crisis throughout the country.

The authorities addressed this runaway situation in 1974–75, during the first period of military government, with an orthodox shock treatment. Although their approach made it possible to restore the flow of goods and finance the external sector, it did not succeed in substantially reducing the domestic inflation rate. The reason given in the literature is the authorities’ persistence in applying a system of indexation and, especially, the need to rebuild the state’s net wealth, which was adversely affected early in the decade. The persistently high rates of inflation and the consolidation of macroeconomic trends (balance of payments, fiscal control, and level of activity) gave rise to the second stabilization effort, launched in 1978, with a system involving prior announcement of the exchange rate. Although this plan succeeded in slowing down the inflation rate, this result was achieved at the cost of an exchange rate appreciation and a strong deficit on the current account, which finally collapsed in 1982.

Following a traumatic adjustment process in 1983 and 1984, by 1985 there was consolidation of a stabilization effort toward the end of the decade that was outstanding in the Latin American context. Its achievements included not only the decline in the inflation rate, but also the rapid recovery of investment, maintenance of the real parity of the exchange rate, and a robust growth in exports. The trend is toward even more success, in that the country has survived two difficult political transitions, and the economy remains solid after more than eight years of growth.

The crucial factor behind this result is firm fiscal discipline, which made it possible to apply a large portion of the growth toward investment and exports, and to build up massive savings from the improved terms of trade in the late 1980s.

In general, the maintenance of public expenditure and real wages in real terms made it possible for the economic expansion to ease the burden on the private sector by way of fewer taxes, higher levels of employment, and more scope for investment financing, which enjoyed extremely low interest rates compared with other Latin American countries.

A persistent weakness is that it has not been possible to bring Chile’s inflation rate down to international levels. This is probably related to the very broad application of the indexation process to the goods and capital markets. Another cause has been the deficit maintained by the monetary authorities, which has been amplified by sterilization operations and by the lack of recovery of the banking portfolios acquired during the crisis of 1982–83.

One result not often mentioned is that the Chilean fiscal situation is healthier than comparative analysis shows, because there is no actuarial accumulation of debt in its social security system, given that estimates for the future are linked to the savings accumulated by citizens in pension funds and not by unrecorded debt in the pay-as-you-go system.

As in the above cases, the quantitative data presented in the appendix tables attempt to illustrate the points made.

Mexico

Unlike Argentina, Mexico had the experience of a lengthy stabilization process, consolidated in the early 1950s and very firmly maintained up to the early 1970s, at which time, and at very high economic and social costs, it began to diverge from a course that had been successful in a number of respects. During this process, the growth rate and monetary stability were very striking, making it possible for the country to make significant progress in comparison with the Argentine experience.

The break with the policy of budgetary equilibrium in the early 1970s finally led downhill to the devaluation of 1976 and the beginning of an inflationary process that would be further heightened by the high level of indebtedness and the fiscal deficit incurred in the late 1970s and early 1980s. These events led to a complete loss of control in 1981–82, which was manifested in major devaluations and the cessation of payments as of August 1982. In December 1982, Mexico launched a program to correct the disequilibrium, involving a lengthy process to clean up the fiscal imbalances. The steps included the restoration of the tax base and a reduction in the level of spending, which led to a strong reconstitution of the primary surplus. The fiscal rehabilitation was made more difficult by various shocks, such as the earthquake of 1985 and the dramatic decline in petroleum prices in 1986.

The lengthy fiscal readjustment ended with the economic solidarity pact concluded in December 1987. The pact involved a speedy stabilization process combining tough, orthodox adjustment with corresponding unorthodox measures in the area of wage and price policies, and an extensive opening up of the economy (a maximum tariff of 20 percent).

Mexico’s structural reform has been impressive. It has included restructuring the tax system, opening up the economy, privatizing public enterprises, and renegotiating the external debt within the framework of the Brady Plan, resulting in write-offs and rescheduling.

The tax reform consisted in broadening the application of taxes, with a reduction in the marginal income tax rate to 35 percent. An assets tax was introduced as a payment against income tax liability. However, the key of the reform was tax administration, where, for the first time, a system of intense auditing was introduced, and criminal action was taken against tax evaders. (Between 1929 and 1988, there were only two criminal indictments for tax evasion, whereas between 1989 and 1991, there were more than two hundred sentencings, all of them involving imprisonment.) A basic element of the reform was a special tax scheme for capital repatriation (approximately $10 billion was repatriated under this system).

This reform was vital to consolidation of the stabilization program in that it made it possible for the Mexican authorities to redeem domestic debt, decrease transfers, and reduce hidden subsidies, so as to strengthen the fiscal position.

The features of the Mexican experience that differ from those of the Argentine experience are the persistence of a significant inflation rate; the exceptional level of the primary surplus; and a smaller rate of economic growth, probably owing to a sharp deterioration in the terms of trade and high domestic interest rates. The persistence of inflation and high interest rates is linked to the type of foreign exchange system adopted, which implies a rate of devaluation and a band of fluctuation that require higher interest rates and involve a higher inflation tax. This system provides a degree of flexibility that the Argentine system lacks.

As in the case of Argentina, the appendix tables presented for Mexico provide an overview and serve as a reference for the arguments advanced above.

Uruguay

Uruguay is an interesting case in that it has been unsuccessful in reducing the inflation rate to figures that can be considered normal, in spite of an extraordinary fiscal effort that has made it possible to reduce the deficit to insignificant levels and to accumulate a substantial primary surplus. This point is particularly sensitive because of the profound dollarization that this economy has been undergoing, following decades of high inflation. Currency substitution in such cases maximizes the cost of monetization of the fiscal deficit. A logical question is why this situation has persisted. Perhaps the dominant factor is the formalization of constitutional indexation clauses. These adjust social security payments with a lag, thereby producing a sort of reverse Tanzi effect. According to this effect, a reduction in the inflation rate produces a rise in the level of government spending, which proves impossible to finance for a country that already has relatively high levels of government spending compared with per capita output.

The coexistence of these two numeraires, one fixed by the monetary authority and the other resulting from indexation, makes durable stabilization impossible without significant structural reform. To understand the problem fully, it is important to note that expenditure on social security in Uruguay is close to 17 percent of GDP, and the rate of inflation is nearly 50 percent. A two-and-a-half-month lag implies a dramatic increase in expenditure even if inflation levels off. This is even more significant if the disequilibrium between commitments and the amounts to be collected largely exceeds GDP as a result of the actuarial debt implicit in the system.

In addition to the relevance of inflation for the short-term fiscal balance, the collection of the inflation tax is making it necessary to redeem net government debt in a country that accumulates it implicitly in its social security system. To some extent, today’s inflation prevents the inflation of tomorrow.

Comment

Felipe Larraín

This is an interesting paper on the topic of stabilization from a policymaker’s perspective. One of its major points is that successful stabilization packages increasingly include supply-side policies along with the more traditional demand-management policies. I agree with this. In fact, one could say that demand policies are necessary, but not sufficient, for successful stabilization.

In a classic paper, Thomas Sargent (1982) pointed out that a change in the regime of fiscal policy (for example, severing links with the printing presses) was essential to stop inflation in all the episodes of hyperinflation that followed World War I. In his words, “the changes that ended the hyperinflations were not isolated restrictive actions within a given set of rules of the game of general policy. Earlier attempts to stabilize… failed precisely because they did not change the rules of the game under which fiscal policy had to be conducted.”1 One could, however, go further than fiscal policy to other fundamental reforms.

Stabilization and Structural Reforms

In many cases, especially in the recent Latin American experience, stabilization would not have worked if traditional demand-management policies had not been complemented by structural adjustment measures. Thus, successful stabilization packages in Bolivia, Mexico, and, more recently, in Argentina have gone together with fundamental reforms of the public sector (including privatization and an overhaul of the tax structure and tax administration) and trade liberalization.

Many of these structural adjustment policies, however, bear fruit only in the medium to long term. This leaves open the question of whether they help stabilization in the short term. A tax reform, for example, is often preceded by heated discussion and takes time to pass in Congress; tax administration cannot be changed overnight.

However, some structural measures, for example, privatization, do help in the short term. Divesting loss-making enterprises helps the budget as privatization proceeds, long before efficiency gains can be factored in. The help comes in two forms: elimination of the fiscal drain incurred in covering the losses, and a significant source of revenue to the government.

Authorities must be careful, though, not to use onetime resources to cover current expenditures. Rather, revenues from privatization should be used to reduce public liabilities and—in limited amounts—to improve the public infrastructure. Trade liberalization also helps stabilization in the short term by providing a benchmark for the prices of tradable goods that become subject to increased competition.

Successful stabilization programs in Argentina, Bolivia, and Mexico have all moved in parallel with trade liberalization. Of these three countries, only Bolivia did not undertake privatization at the time of the stabilization effort, but it did include substantial state reform, including the closing of several state-owned, loss-making mines in the government mining company Comibol.

Probably the most crucial aspect of structural measures in supporting stabilization is their effect on expectations, because they signal a change in regime. Credibility is a key element in the success of a stabilization program, and success normally does not come on the first try.2 Why should agents accept that the government is serious, especially after several failed attempts? Economic authorities have an easier task of convincing people if they implement a major, coherent reform package along with the usual stabilization policies.

One major area where structural reform is crucial for sustained stabilization is—broadly defined—fiscal policy. Merely closing a fiscal deficit through some combination of emergency taxes, cuts in public investment, and the reversal of the Oliveira-Tanzi effect may not be enough. In many cases, only an in-depth reform of the state can guarantee that fiscal deficits will not recur.3

Role of Institutions

The paper mentions one interesting institutional element that has been essential in some stabilizations: the fiscal organization in countries with federal systems. No doubt, the author is influenced by the case of his own country, where quasi-fiscal deficits of more than 20 percent of GDP in the last two decades were largely explained by central bank credits to provincial banks, which, in turn, financed provincial governments.

Today, fiscal federalism is an important topic, not only in Argentina and Brazil, but also in such countries as Russia. In Argentina, tax co-sharing used to imply that the national treasury received only about 42 percent of increased collections. Because export taxes and government fees were exempted from co-sharing, stabilization programs relied especially on these instruments. This was not the most efficient mix, but rather one that responded to the institutional realities of the country.

This link has gradually eroded in Argentina over the past few years and has been a crucial aspect in Argentina’s current stability. Brazil, also a federal country, has yet to succeed in stabilizing its economy. There are some important lessons for Brazil to learn from Argentina’s reform of the cosharing scheme and the severance of links between the provinces and the central bank.

A second institutional area that the paper mentions is the organization of social security. The basic issue is the accumulation of huge liabilities in state-run social security systems, which ultimately cannot be covered from the assets of the system, so that the government is called upon to finance the flow deficit. The problem is not with social security itself but rather with pay-as-you-go systems, which are hostage to two types of pressure. One is the lobbying from special interest groups that normally obtain increased benefits without commensurate increases in contributions. The other is demographic: the reduction of birthrates and the increase in life expectancy of the population, which—given retirement ages—increase the burden on the current workers. In contrast, a social security scheme based on capitalization and individual accounts avoids both of these pressures and partially explains why several countries in Latin America are switching to this scheme. The difficult part, of course, is to finance the transition period.

A third major institutional area—one not mentioned by the paper—is the move to independent central banks. International evidence indicates a clear inverse relationship between central bank autonomy and inflation. A widely quoted study by Alberto Alesina shows a clear negative correlation between the two variables for industrial countries.4 Alesina built an index of independence and showed that countries with more autonomous central banks had lowered average inflation during 1973–86.

Many countries in Latin America are granting increased independence to their monetary authorities. In the context of stabilization, one needs to answer the question of why the central bank will deny financing to the public sector the next time it is requested. In such a situation, autonomy is important. In some countries with a long history of inflation, such as Argentina, the law prohibits monetary financing of fiscal deficits.

Stopping High Versus Moderate Inflation

One issue that the paper does not discuss is the important difference between stabilization of very high inflation and hyperinflation and stopping moderate inflation.5 This is a central issue in Latin America today because—unlike a few years ago—most countries are fighting moderate inflation. A crucial distinction is indexation. Very high inflation and hyperinflation tend to destroy indexation (with the notable exception of Brazil). Reducing moderate inflation is harder, however, in the presence of indexation, which adds inertia to the inflation process.

The most damaging aspect of indexation is backward-looking wage adjustments in labor contracts. In Chile, indexation was established by law in 1979 (for workers under collective bargaining) and abolished in 1982. But the practice remained, and workers still look at past inflation when bargaining with their employers. The situation is more complicated in Uruguay, where the requirement to adjust pensions for past inflation has constitutional status and applies with a two-and-a-half month lag. This fact, together with widespread dollarization, helps explain why Uruguay’s inflation is stuck at about 50 percent when the fiscal budget is balanced. It is important, then, to eliminate legal and constitutional mandates for indexation.

Stabilization and Currency Appreciation

An interesting aspect of the 1990s is that countries are trying to reduce inflation in the midst of strong capital inflows that put downward pressure on the exchange rate. This is a double-edged sword. Exchange rate appreciation helps reduce inflation, but at the cost of reducing the competitiveness of a country’s tradables sector. In recent years, Argentina and Mexico have faced this trade-off most vividly.

Past experience suggests, however, that one should avoid the temptation of leaning too heavily on the exchange rate as a stabilization device. Countries in the Southern Cone of Latin America learned a painful lesson in the late 1970s and early 1980s, when the use of active crawls to stop inflation was popular.6

Appendix Tables

Argentina

Table 2.1.

Public Sector Accounts

(In percent of GDP)

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Source: Argentina, Secretaría de Ingresos Públicos.Note: Table 2.1 describes the situation of the nonfinancial public sector (NFPS). Only toward 1993 did the primary surplus net of capital resource make it possible to deal with interest on the debt.
Table 2.2.

Summary of Public Sector Operations

(In percent of GDP)

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Note: Table 2.2 deals with the same items as Table 2.1, with a few methodological differences (interest is recorded on a different basis). It takes account of the revival of collections and the growth in social security expenditure and in transfers to the provinces. Another notable features is the decline in the share of public enterprises and the fall in public investment as a result of privatization. The other significant consequence is the decline in the Central Bank’s deficit; owing to lower net indebtedness, the primary balance is very low, particularly if an adjustment is made for capital inflows.
Table 2.3.

National Tax Revenue

(In percent of GDP)

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Source: Argentina, Secretaria de Ingresos Públicos.Note: Since the convertibility law, the interest earned on foreign exchange reserves is included in seigniorage.Table 2.3 shows a series of actual taxes established by law and what might be called the “tax on issues” (inflation tax and seigniorage). The most noteworthy aspect is the strong expansion of the VAT and the significant decline in the tax on external trade and on issues. The tax on issues, especially, should be compared in the Plan Austral and in the convertibility plan.
Table 2.4.

Liquidity Coefficient

(In percent)

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Source: United Nations, Economic Commission for Latin America and the Caribbean.Note: Table 2.4 provides monetization indicators, showing the considerable destruction of the local financial system and the sharp decline in velocity that occurred with stabilization.
Table 2.5.

Annual Rate of Inflation

(CPI)

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Note: Table 2.5 shows consumer inflation rates. In only 2 years of the first 15 years for which records were kept was the inflation rate lower than 100 percent, and then only slightly so.
Table 2.6.

National Income, Saving, and Investment1

(In percent of GDP; relative price 1986)

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Source: United Nations, Economic Commission for Latin America and the Caribbean.

Deflated by import prices.

Note: Data for all years are preliminary. Table 2.6 shows the aforementioned national savings problem. The decline by nearly 10 percent in terms of GDP is the reason for the weakness of the process of accumulation and external disequilibrium.
Table 2.7.

Real Effective Exchange Rate

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Note: The strength of the stabilization is related to the decline in national savings and to the appreciation of the dollar against other currencies in the past two years.
Table 2.8.

External Trade: Value, Volume, and Price Indices

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Sources: Central Bank of Argentina; National Institute of Statistics; IMF staff estimates.Note: Table 2.8. shows the foreign trade numbers. Noteworthy here are the deterioration in the terms of trade and the marked increase in the volume of exports in the 1980s.
Table 2.9.

External Trade Prices

(1970 = 100 unit value in U.S. dollars)

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Source: United Nations, Economic Commission for Latin America and the Caribbean.

Preliminary.

Estimated.

Note: Table 2.9, which complements the previous one, shows that nominal export prices for 1991 were 33 percent lower than for 1981. With the nominal interest rates for the decade, this makes any further comments on the external shock unnecessary.
Table 2.10.

Exchange Rates

(In November 1993 pesos)

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Note: Table 2.10 shows a few exchange rate comparisons. The figures tend to confirm a visitor’s impression of Argentina; this country is very expensive in dollars.
Table 2.11.

Privatization, 1990–94

(Current = millions of U.S. dollars)

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Cashpaid when the enterprise was acquired.

Face value of internal or external bonds swapped by public asset.

Cash plus market value of public bonds. The implicit parities are Aerolineas Argentina and ENTEL, 15.6 percent; Petroquimical, 14.4 percent; Zapla, 46 percent; others, 53.75 percent. In 1993, the market value used was 60 percent.

The figure is the sum of the account sold by the provinces and the federal government.

Note: Not included are the liabilities of the public enterprises that were transferred to the buyers, by $2 billion.Table 2.11 gives estimated earnings from the sale of government assets. If transferred liabilities are added to these and the face value of debt is calculated, the total is a little more than $25.5 billion.
Table 2.12.

Public Expenditure

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Source: Argentina, Ministry of the Economy, Public Works and Services.

Preliminary estimate of Carta Economica.

Note: Public expenditure is the sum of the nonfinancial public sector plus mandated health insurance, plus local governments, plus provincial government, excluding treasury transfers.Table 2.12 shows government expenditure measured in terms of the monetary anchor, adjusted for the size of the economy and the international inflation rate. The substantial exchange revaluation and the decline in savings are related to the considerable expansion of government expenditure, which was concentrated on social security. (To make this account worse, payments on the consolidated debt and the sale of YPF, the Argentine oil company, are not recorded.)

Chile

Table 2.13.

Economic Index

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Sources: D. Simone, “Stabilization of the Argentine Economy: The Convertibility Program, 1991–92” (Unpublished, 1993); and R. Arriazu and D. Simone, “Chile : Receiving the Benefit of Structural Reform,” Emerging Market Research, Salomon Brothers (September 1992).Note: Table 2.13 shows trends in the macroeconomic indicators, pointing to the high rate of growth, the decline in government current expenditure, the considerable improvement in the terms of trade (unlike what occurred in the other countries studied), and the dramatic recovery of domestic savings.
Table 2.14.

Inflation and Devaluation Rates

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Source: Central Bank of Chile.Note: The asymmetry in the late 1970s is noteworthy, as is the successful real devaluation achieved after 1982. The persistence of inflation and devaluation in spite of economic is successes linked to the desire to have a way out in case of a serious deterioration in the terms of trade.
Table 2.15.

General Government Expenditures and Nonfinancial Public Sector Financing Requirements

(As a percentage of GDP)

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Sources: Chile, Ministry of Finance; private research institutions; and R. Arriazu and D. Simone, “Chile: Receiving the Benefit of Structural Reform,” Emerging Market Research, Salomon Brothers (1992).

Estimate.

Projected budget law for 1992.

Adjusted in January 1992.

Note: NPSF = nonfinancial public sector. Table 2.15 gives a broader view of the fiscal accounts, which show that the contraction in expenditure does not affect government investment.
Table 2.16.

Summary Operations of the Nonfinancial Public Sector

(In percent of GDP, unless otherwise indicated)

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Adjusted to exclude privatized enterprises.

Preliminary.

Net of taxes and transfers.

Note: Table 2.16 provides another version of the fiscal accounts, in which it is useful to note the effect of the Copper Stabilization Fund, although its operations were canceled, and the persistence of a fiscal surplus. This occurs even when the Central Bank’s losses are included. Particularly noteworthy is the size of the government’s current savings and how they contribute to the country’s overall savings.
Table 2.17.

Saving and Investment in the Economy

(in percent of nominal GDP)

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Sources: R. Laban and Felipe Larraín, “Continuity and Change in the Chilean Economy” (Unpublished, 1992); Central Bank of Chile; Ministry of Finance.

Average.

Projected by the authors (which includes the only commercial bank owned by the Chilean government).

Note: NFPS = nonfinancial public sector. Table 2.17 shows the substitution of external savings for domestic savings and the possibility of financing an increasing volume of investment.
Table 2.18.

Evolution of Imports and Exports and the Real Exchange Rate

(in percent of nominal GDP)

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Source: Central Bank of Chile, national accounts.

In 1977 pesos.

Average for January-October. Assumption of real GDP growth for 1992 is 8.5 percent.

Note: Table 2.18 shows exports and imports as shares of GDP and the real exchange rate. As pointed out, the real growth of exports is observed, together with its increasing share in GDP.

Mexico

Table 2.19.

Public Finance Indicators

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Sources: Presidency of the Republic, Criteria for Economic Policy in 1992; Pedro Aspe Armella, Economic Transformation the Mexican Way (Cambridge, Massachusetts: MIT Press, 1993).Note: Table 2.19 shows the fiscal indicators, the most important of which is the primary deficit, which changed by nearly 15 percent of GDP between 1982 and 1990.
Table 2.20.

Public Finance Indicators

(In percent of GDP)

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Sources: Mexico, Minstry of Finance. The numbers for 1991 are taken from Presidency of the Republic, Criteria for Economic Policy in 1991.Note: The above numbers exclude expenditures, capital expenditures, and transfers to noncontrolled enterprises. Table 2.20 shows complementary public sector indicators, from which the recovery of tax revenue is clear, as are the decline in current expenditure and interest on foreign debt, which are reduced almost by half. Domestic financial outlays are affected by the measurement of inflation, which is why their decline in real terms is overestimated. In any case, the interest burden is five times greater in Mexico than in Argentina; this explains the substantial difference in the primary surplus to be achieved (the cost of maintaining PEMEX instead of redeeming debt).
Table 2.21.

Financial Indicators

(In percent)

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Sources: Bank of Mexico; Aspe Armella (1993).

Housing bond rates before 1973; after 1973, average cost of funds of the banking system.

(M4/GDP); the most comprehensive definition of money at the time is used throughout the series.

As a fraction of GDP; includes the public financial sector.

Note: Table 2.21 provides information on trends in the monetary aggregates (M4/GDP), together with trends in GDP, the inflation rate, nominal interest rates, the inflation tax, and credit to the government The destruction caused by the increase in the inflation tax in the early 1970s is particularly noteworthy, as its marginal yield falls compared with the rate of inflation. Inflation rates of 20 percent in the 1970s generated income representing 4 percent of GDP; in the 1990s, this has declined to only 0.4 percent of GDP. The other point to be highlighted is the enormous effort required to redress the inflationary situation of the 1970s and 1980s.
Table 2.22.

Investment and Savings Performance

(In percent of GDP)

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Sources: Bank of Mexico, Indicadores Económicos; and Ministry of Finance.

Gross fixed investment plus changes in inventories.

Defined here as the difference between domestic savings (investment-external savings) and public savings.

Government deficit minus public sector investment.

Note: Table 2.22 shows ratios of investment to saving. Mexico maintains a significant level of domestic savings, which has enabled it to generate a high rate of investment, even though it achieved only low per capita growth.