face of repeated failures. Brazil, Argentina, Chile, and Peru have had multiple
episodes of failed populist policies since the end of World War II. Yet
new generations of leaders seemingly have not learned from history and
continue to reach for populism's simplistic solutions. Arguably, in the process,
they have made matters worse.
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I regret populist movements' disregard of previous economic failure in
their struggle to articulate an answer to their current distress, but I am not
surprised by it or by their rejection of free-market capitalism. In fact, I confess,
with no small sense of irony that I have always been puzzled by the willingness
of large and often poorly educated populations and their governmental
representatives to adhere to the rules of market capitalism. Market capitalism
is a broad abstraction that doesn't always conform to untutored views of the
way economies work. I presume markets are accepted because of their long
history of creating wealth. Nonetheless, as people often complain to me: "I
don't know how it works, and it always seems to teeter on the edge of chaos."
That is not an altogether illogical feeling, but, as is taught in Economics 101,
when a market economy periodically veers off a seemingly stable path, competitive
responses act to rebalance it. Since millions of transactions are involved
in the rebalancing, the process is very difficult to grasp. The abstractions
of the classroom can only hint at the dynamics that, for example, enabled the
U.S. economy to stabilize and grow after the September 11 attacks.
Economic populism imagines a more straightforward world, in which
a conceptual framework seems a distraction from evident and pressing
need. Its principles are simple. If there is unemployment, then the government
should hire the unemployed. If money is tight and interest rates as a
consequence are high, the government should put a cap on rates or print
more money. If imported goods are threatening jobs, stop the imports. Why
are such responses any less reasonable than supposing that if you want a car
to start, you turn the ignition key?
The answer is that in economies where millions of people work and trade
every day, individual markets are so intertwined that if you cap an imbalance,
you inadvertently trigger a series of other imbalances. If you put a price ceiling
on gasoline, shortages emerge and long lines at filling stations develop, as became
all too apparent to Americans in 1974. The beauty of a market system
is that when it is functioning well, as it does almost all the time, it tends to
create its own balance. The populist view is equivalent to single-entry bookkeeping.
It scores only credits, such as the immediate benefits of lower gasoline
prices. Economists, I trust, practice double-entry bookkeeping.
Burdened by its dearth of meaningful economic policy specifics, populism,
to attract a following, has to claim a moral justification. Accordingly,
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populist leaders must be charismatic and exhibit a take-charge aura, even an
authoritarian competence. Many, perhaps most, such leaders have come out
of the military. They do not effectively argue for the conceptual superiority
of populism over free markets. They do not embrace Marx's intellectual formalism.
Their economic message is simple rhetoric spiced with words like
"exploitation," "justice," and "land reform," not "GDP" or "productivity."
To peasants tilling the soil of others, redistribution of land is a cherished
goal. Populist leaders never address the potential downside, which can be
devastating. Robert Mugabe, president of Zimbabwe since 1987, promised
and delivered to his followers the confiscated land of white settlers. But the
new owners were not prepared for management of the land. Food production
collapsed, necessitating large-scale importation. Taxable income fell
sharply, requiring Mugabe to resort to printing money to finance his government.
Hyperinflation, at this writing, is unraveling Zimbabwe's social
compact. One of Africa's historically most successful economies is being
destroyed.
Hugo Chavez, who became Venezuela's president in 1999, is following
Mugabe's example. He is ravishing and politicizing Venezuela's once-proud
oil industry—the second largest in the world a half century ago. The level
of essential oil-field maintenance declined sharply when he replaced most
of the government-owned oil company's nonpolitical technicians with cronies
of his regime. That caused a permanent loss of several hundred thousand
barrels a day of productive capacity. Venezuelan crude oil output
dropped from an average of 3.2 million barrels a day in 2000 to 2.4 million
barrels a day during the spring of 2007.
Yet fortune has smiled on Chavez. His policies would have bankrupted
most any other nation. But since he became president, world oil demand
has engendered a near quadrupling of crude oil prices and has, at least for
now, bailed him out. Counting its heavy crude oil, Venezuela may well
have one of the largest petroleum reserves in the world. But oil in the
ground is no more valuable than when it lay dormant for millennia unless
you can create an economy to extract it.*
That happened to Venezuela in 1914, the year Royal Dutch Shell brought the technology
needed to develop its riches.
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A significant dilemma plagues Chavez in his political stance. Two-
thirds of his country's oil revenue comes from oil shipped to the United
States. It would be quite costly to Venezuela to wean itself from its major
customer, because it largely produces a heavy sour crude that requires the
capability of U.S. refineries. Diverting oil to Asia would be possible but very
costly. Higher prices, of course, would give Chavez room to absorb the extra
costs. But by ratcheting up his buying of influence abroad and political
support at home, he is gradually, but inexorably, tying his political future to
the price of oil. He needs ever-higher prices to prevail. Fortune may not
smile on him forever.
The world should be relieved that not all charismatic populists behave
like Chavez and Mugabe when gaining office. Luiz Inacio Lula da Silva, a
Brazilian populist with a large following, was elected president in 2002.
In anticipation of his victory, Brazilian stock markets fell, inflation expectations
rose, and much intended foreign investment was withdrawn. But to
the surprise of most, myself included, he has largely followed the sensible
policies embodied in the Piano Real, which Cardoso, his predecessor, had
introduced in taming Brazil's hyperinflation of the early 1990s.
Economic populism makes large promises without considering how to
finance them. Too often, delivering on the promises results in a fiscal revenue
shortage and makes it impossible to borrow from the private sector or
foreign investors. This almost always leads to desperate reliance on the central
bank to serve as paymaster. Requiring a central bank to print money to
increase government's purchasing power invariably ignites a hyperinflationary
firestorm. The result through history has been toppled governments
and severe threats to societal stability. This pattern characterized Brazil's
inflation episode of 1994, Argentina's of 1989, Mexico's of the mid-1980s,
and Chile's of the mid-1970s. The effects on their societies were devastating.
As the well-regarded international economists Rudiger Dornbusch and
Sebastian Edwards established, "at the end of every populist experiment,
real wages are lower than they were at the beginning." Hyperinflation pops
up periodically in developing nations—in fact it is one of their defining
tendencies.
Can Latin America turn its back on economic populism? Over the past
two decades, despite repeated failures of macroeconomic policy, or perhaps
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because of them, the major countries in the region have nurtured a coterie
of economic technicians who certainly have the credentials to lead Latin
America in a new direction. The list is studded with policymakers of exceptional
talent, most of whom I have had the privilege of working with during
some very difficult times in recent decades: Pedro Aspe, Guillermo Ortiz,
Jose Angel Gurria, and Francisco Gil Diaz in Mexico; Pedro Malan and Arminio
Fraga Neto in Brazil; Domingo Cavallo in Argentina; and others.
Most hold advanced degrees in economics from prestigious American universities.
Some even went on to become heads of state—Ernesto Zedillo in
Mexico and Fernando Henrique Cardoso in Brazil. Most instituted productive
market-freeing reforms and policies in the face of deep populist resistance,
policies that enhanced their economies. Latin America would be in
far worse shape without these able practitioners, in my judgment. But the
deep divide between the worldview of most of these policymakers and the
societies they serve, which remain prone to economic populism, is stubbornly
persistent.
Latin America's tenuous hold on economic stability was brought into
sharp focus in 2006 by the presidential election in Mexico, which has the
region's second-largest economy. Despite much success since the foreign-
exchange crisis of late 1994 brought Mexico to the edge of default, a firebrand
populist—Andres Manuel Lopez Obrador—came within a hairbreadth
of being elected president. Whether he would, in office, be more Lula than
Chavez, I cannot guess.
Can a society with deep economic populist roots change quickly? Individuals
can and have. But can a developed economy's market structure—its
laws, its practices, its culture—be imposed on a society bred on ancient antagonisms?
Brazil's Piano Real suggests the possibilities.
Since stabilizing in 1994, Brazil's inflation has been contained, except
for a transitory price surge during its 40 percent exchange-rate devaluation
in late 2002. Its economy has performed well and standards of living have
risen. To be sure, the failure of the devaluation to spark more than a short-
term eruption of inflation may be tied more to global disinflationary forces
than to domestic policy, but the Brazilian economy seems to be working for
the Brazilian people.
The experience of Argentina, on the other hand, is more sobering. Its
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economy collapsed in 2002; as the decade-long constitutionally mandated
one-to-one link of the Argentine peso to the U.S. dollar broke, with vast
disruption to employment and standards of living. The story of the debacle
is instructive as to how far reform-minded policymakers can go without the
implicit support of the population for the necessary fundamental policies.
A society's drive to meet current needs, for example, cannot be thwarted
by the imposition of a financial straitjacket. The society must experience
progress and trust its leaders before it is willing to invest for the longer term.
This change of culture typically takes a very long time.
Argentina was, in most respects, a European culture prior to World War I.
A succession of failed economic programs, and periods racked with inflation,
created economic instability. Argentina lost ground in international economic
comparisons, especially during the autocratic regime of Juan Peron.
Its culture was gradually, but significantly, changing. Even the post-Peron
regime of the well-intentioned Raul Alfonsin failed to stem the explosive
inflation and stagnation of the heavily regulated Argentine economy.
Finally, in 1991, the situation became so desperate that the newly
elected president, Carlos Menem, who ironically ran under the banner of
Peron, turned to his able finance minister, Domingo Cavallo, for help. With
President Menem's backing, Cavallo tied the Argentine peso one-to-one to
the American dollar. This extremely risky strategy could have blown apart
within hours of implementation. But the boldness of the move and the
seeming credibility of the commitment galvanized world financial markets.
Argentine interest rates dropped sharply, inflation fell from 20,000 percent
year over year in March 1990 to a single-digit annual inflation rate by late
1991.1 was amazed and hopeful.
As a result, the Argentine government was in a position to raise large
quantities of dollars in the international markets at interest rates only moderately
higher than those required of the U.S. Treasury. The reform views of
Cavallo sounded far more sensible to me than the uninformed rhetoric
coming at the time from many Argentine legislators and provincial governors.
Their views were too reminiscent of the fiscal irresponsibility of earlier
decades. I recall looking across the table at Cavallo at another G20
meeting and wondering whether he was aware that the lending backstop to
the peso would remain a source of support only if it was not used in excess.
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Maintaining that large dollar buffer would likely have enabled the currency
peg to hold indefinitely However, the political system of Argentina could
not resist using the abundance of seemingly costless dollars in attempts to
accommodate constituents' demands.
Gradually but inexorably the buffer of dollar-borrowing capacity was
drawn down. Dollars often were borrowed to sell for pesos in a futile effort
to support the peso-dollar parity. The bottom of the barrel was reached at
the end of 2001. Protecting its remaining reserve of dollars, the central
bank withdrew its one-for-one offer of dollars for pesos in international
markets. As a result, on January 7, 2002, the peso collapsed. By mid-2002,
it took more than three pesos to buy one dollar.
A massive default of Argentine debt induced an initial period of soaring
inflation and interest rates, but much to my surprise, financial calm was
