How to End Global Economic Insecurity

People from the Yucatan Peninsula, descendants of Mayan culture, have a wise saying: “All excess is excessive.” It also appropriately defines the scope of the Latin American debate on economic policies. We have gone from one extreme of the pendulum to the other.

Brazil’s current economic troubles, in the wake of Asia’s financial insecurity, sharpen the choices. Should Brazil hold fast to the reigning model of economic development, let markets regulate capital flows and risk continued financial volatility? Should it embrace Malaysia’s solution, instituting some form of capital controls as the way to bring economic stability to the country? Or is there another way for Brazil, and any emerging economy, to enjoy greater stability without scaring off foreign investors?

After World War II, the vast majority of countries in Latin America adopted economic policies that relied on heavy doses of protectionism, aggressive government intervention and regular stimulation of the domestic market, with little concern about how these approaches affected the region. Although much criticized, these policies allowed many countries to industrialize and establish institutions that promoted social and economic development. More recent economic programs could not have been instituted if these changes had not occurred.

But protectionism went too far, intruded into too many sectors and lasted too long. It also created swelling budget deficits, high inflation, overvalued currencies, trade imbalances and a bulky public sector that provoked recurrent economic and political crisis. The tug of war between the two superpowers also made Latin American governments adopt expansionist social-spending policies to reduce pressure from leftist groups throughout the region.

In August 1982, Latin America’s external-debt crisis exploded. As the region became a net exporter of capital, its chances for economic development diminished. The weight of interest payments plus loan principal became overwhelming. Funds flew out of countries at a faster pace than they were arriving. As savings left, so did the prospects for economic growth.

Meanwhile, an ideological revolution that would bring serious structural changes to the region’s economies began to unfold. The new model, pushed by the United States, heralded open economies, export-oriented businesses, privatization, deregulation, sounder public finances through lower social spending and less-intrusive government.

Latin America’s adoption of the neoliberal model, which ensured a steady diet of foreign capital, had dramatic effects. The region’s legendary inflationary ills eased. By the early 1990s, regional economic performance improved. Exports were particularly dynamic.

But the opening of Latin economies to imports, and some of the structural changes that followed, happened at an excessively accelerated pace with no clear sense of priorities. The region scrupulously and unquestioningly followed the orders of the Washington consensus. Many times, it seemed as if international financial organizations and the U.S. Treasury were dictating policy, and when the Soviet Union ceased to be a threat, pressures to expand social spending withered away.

Now, though the global economy is losing some of its dynamism, global trade and the flow of capital keep on growing at a fast pace. At the same time, the number of people left behind grows, even in the industrialized countries. The gap between rich and poor countries, and rich and poor people, widens, and the increasing volatility of financial markets creates ever more uncertainty, raising risk. Lately, this pervasive feeling of uncertainty has provoked among emerging economies a new debate about a different path, a “third way,” to economic security. Latin America is actively involved in this intellectual ferment and is seeking to identify a new role for government vis-a-vis markets.

The Brazilian situation aptly illustrates the debate. In a global world, says the neoliberal creed, imposing controls on the free flow of capital is anathema. It runs against a basic principle of goods and services freely moving among and within countries. There have always been some kinds of exchange controls. But, as a general rule, they are meant to manage the entry and exit of currencies to reduce the inherent risks of international economic relations.

But wherever some form of capital controls have been implemented, the experience hasn’t been successful, especially when they are long term. Furthermore, in a world where the norm is the absence of such controls, resorting to them reduces sources of foreign capital and puts pressure on domestic economies to produce more.

By abiding by an absolute free flow of capital and other neoliberal economic advice, a country can count on foreign investment. The problem is that these investments are often merely speculative or simply contribute to an increase in consumption, which adds little lasting benefit to the receiving country. It should also be noted that often an investor lacks information on the regulatory and supervisory mechanisms of the country in which he is investing. As a result, the investor tends to pull his money out at the slightest hint of trouble.

Right now, it is difficult to anoint the neoliberal model, Brazil’s way, or one that uses some form of capital controls, Malaysia’s way, as the best path to economic stability and growth for developing countries. Yet, in reducing the financial volatility and uncertainty that mark today’s global economy, government may be in the strongest position to do something. It is a responsibility of government to be a stabilizing influence in world economic affairs, and not just those governments of emerging economies. The governments of the industrialized countries should not simply sit on the sidelines and watch their international investors put foreign economies into play.

The market may be the best instrument to allocate scarce resources in an economy, but it nevertheless leaves many holes uncovered and provokes many distortions that only government may be able to rectify and avoid. In Latin America, with all the shortages it endures and the challenges it faces, a third way involving more active government, government that is strong, efficient, democratic and honest, may be the antidote for economic insecurity.