A Fork in the Road

• Author: Arminio Fraga
• Position: President of Brazil's central bank from 1999 to 2002, is currently a partner at Gávea Investimentos, Rio de Janeiro, Brazil

Latin America faces a choice between populism and deeper reform

On the surface, the IMF's recent growth numbers for Latin America are quite encouraging: almost 4.8 percent average growth for 2004-05, and a forecast of 3.8 percent for 2006. This is an impressive turnaround when measured against the 1.4 percent average for 1999-2003. But the news is not quite as good when measured against the more exuberant backdrop of world growth-estimated at 4.7 percent in 2004-05 and expected to remain at 4.3 percent in 2006. Moreover, if we look at 1997 through what is projected for 2006, Latin America will have grown at 2.8 percent while world growth will have averaged 3.9 percent, split between 2.7 percent for the advanced economies and 5.3 percent for the emerging and developing countries. This lack of convergence in incomes relative to the advanced economies is quite disturbing, as is the underperformance relative to other developing countries, especially in Asia. What is the matter with Latin America? Why has growth lagged other emerging regions by so much? Have we seen progress in recent years? And are we heading in the right direction?

The lost decade(s)

To gain insight into these issues, it pays to begin with a review of the 1980s and 1990s. The 1980s became known in Latin America as the "lost decade" because per capita output growth averaged a shocking negative 0.6 percent a year, after the outstanding 3.8 percent performance of the 1970s (as measured by the GDP-weighted average of the seven largest economies in the region). This decade was marked by economic chaos in most countries in the region, and included multiple episodes of hyperinflation, international debt default, and deep recessions.

All over the region, nonorthodox approaches to macroeconomic stabilization were tried with tragic results. Brazil, for instance, struggled for years with a series of unconventional plans to curb inflation, each one failing as they did not address basic matters such as loose fiscal and monetary policies. Price freezes, asset freezes, and exchange rate pegs of all kinds were attempted in quick succession.

As the 1980s came to an end, it became clear throughout Latin America that certain basic elements of sound economic management had to be present to create an economic background conducive to growth and development. These elements, which...