Latin America's International Relations and Their Domestic Consequences

War and Peace, Dependence and Autonomy,

Jorge I Dominguez

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781135564698
• Edition: 1
• Topic: Social Sciences
• Subtopic: Sociology
• Index: Social Sciences

First Published in 1994. Volume 6 in the 7-volume series titled Essays on Mexico, Central and South America: Scholarly Debates from the 1950s to the 1990s. The central scholarly articles concern interstate peace along with a U.S. propensity to intervene, and international structural vulnerabilities and economic asymmetries along with the significance of elite skills and choices. This title recognises that scholars have paid more attention to international economics in Latin America and seeks to balance the range study.

The Debt Crisis*

Structural Explanations of Country Performance

Andrew Berg

Massachusetts Institute of Technology, Cambridge, MA 02139, USA

Jeffrey Sachs

Harvard University, Cambridge, MA 02138, USA

This paper develops a cross-country statistical model of debt rescheduling, and the secondary market valuation of LDC debt, which links these variables to key structural characteristics of developing countries, such as the trade regime, the degree of income inequality, and the share of agriculture in GNP. Our most striking finding is that higher income inequality is a significant predictor of a higher probability of debt rescheduling in a cross-section of middle-income countries. We attribute this correlation to various difficulties of political management in economies with extreme inequality. We also find that outward-orientation of the trade regime is a significant predictor of a reduced probability of debt rescheduling.

1. Introduction

The debt crisis can be studied as a problem in epidemiology. A powerful virus, high world interest rates, hit the population of capital-importing developing countries in the early 1980s. Some countries succumbed to the virus, having to reschedule their debts on an emergency basis, while others did not. And of those countries that arrived for emergency treatment, some recovered sufficiently to enter a period of quiet convalescence, while others are still suffering from febrile seizures in the IMF’s intensive care unit.

The epidemiologist studies the progression of a disease in order to understand the disease better, and to recommend improved forms of treatment. For the same reason, it is important to understand why some countries fell prey to the debt crisis while others did not, and why some countries have recovered from the crisis while other countries remain deeply enmeshed in it. The goal of our paper is to find answers to these questions, and then to draw inferences about the fundamental nature of the debt crisis itself. Was the crisis mainly the result of external shocks, internal policy mistakes, the organization of political power within the debtor countries, or other structural features of those economies that succumbed to crisis?

Several earlier studies [e.g. Cline (1984), McFadden et al. (1985)] have tried to identify the proximate causes of the debt crisis by estimating a probability model of rescheduling for a cross-section of debtor countries. Typically, such studies try to explain the crisis by looking mainly at the cross-country variation of a set of financial variables, such as the ratio of debt service to exports, the ratio of foreign exchange reserves to imports, and so forth. These studies are problematical, however, since many of the supposedly ‘causal’ variables (e.g. low foreign exchange reserves) are really symptoms of the crisis rather than fundamental causes, and, moreover, we learn little about the kinds of policies or structural conditions within an economy that lead to the adverse changes in the financial variables.

Our study seeks to identify causes of the debt crisis that are more fundamental than the values of financial variables on the eve of rescheduling. Several earlier studies provide us with the foundation for such an analysis. Balassa (1982), Sachs (1985), and many others, for example, have shown that the foreign trade regime in each country is an extremely important determinant of which countries succumbed to the debt crisis, and which ones did not. The accumulated evidence is clear that outward-oriented trade policies, such as those pursued in East Asia, have been successful in raising the share of exports in national production, spurring overall growth, and providing the foreign exchange earnings to service foreign debts without reschedulings in the 1980s.

Other studies such as those in the NBER Study on Foreign Debt [edited by Sachs (1988)] stress the political prerequisites for avoiding a debt crisis, and for recovering from such a crisis after it begins. It appears that in many developing countries, the reliance of a government on heavy foreign borrowing of the 1970s was determined by the political needs of the incumbent government, rather than by calculations of intertemporal economic efficiency. Foreign borrowing was, in many cases, a way for governments to satisfy intense social demands for higher government spending without having to suffer (in the short-term) the political consequences of higher tax collections or the inflationary consequences of money-financed deficits.¹

In our view, the political pressures for excessive foreign borrowing tend to be more acute in economies with extreme inequalities of income. In such economies, the pressures for redistributive policies tend to be greatest, while the ability of the wealthy to resist the pressures for income redistribution also tend to be strong given their signifīcant command over economic and political resources in the country. Competing interest groups tend to see very little commonality of interests given the wide disparities in income, and the economic policies that result from this distributional tug-of-war may tend to be short-sighted and to oscillate widely over time. In many Latin American countries, for example, urban workers support populist regimes, while landowners and other economic elites often support highly repressive governments that promise to suppress worker demands. Policies vary significantly as these groups alternate in political power.

Another key dimension of the political system is the extent to which agricultural versus urban interests influence the political decisions over economic policymaking. Huntington (1968) and other political scientists have stressed that in the case of developing countries, urban politics tends to be a cauldron of instability and populist policies. Governments are most secure which find a significant base of support in the agricultural sector, which tends to favor more conservative and stable policies. In Huntington’s (1968) words:

‘In modernizing countries the city is not only the locus of instability; it is also the center of opposition to the government. If a government is to enjoy a modicum of stability, it requires substantial rural backing. If no government can win the support of the countryside, there is no possibility of stability’ (p. 435).

‘In some instances, urban revolts may overturn rural-based governments, but in general governments which are strong in the countryside are able to withstand, if not to reduce or eliminate, the continuing opposition they confront in the cities’ (p. 437).

These considerations lead us to expect that the structural importance of agriculture in the economy, which we measure roughly as the share of agriculture in GNP, will help to predict the extent of political stability, and by extension, the proneness of countries to an external debt crisis.

Several other variables have been mentioned by observers of the debt crisis as possible structural factors which may raise or lower the probability of debt crisis in a particular country. Possible explanatory variables include: movements in the terms of trade; the structure of foreign trade (e.g., the share of manufacturing goods versus primary products in total exports, and the extent of the commodity diversification of exports); the level of per capita income in the country; and the geographical location of the country, especially if there are regional ‘contagion effects’ in commercial bank lending.

The size of the debt burden (e.g., the debt-export ratio) at the time of the rise in real interest rates in the early 1980s helps to explain the effect of the debt crisis in the various countries. We expect that our structural variables should help to explain the debt-exporter ratios of the individual countries (e.g., more unequal countries will have a higher expected debt-export ratio). We also expect independent effects of our structural variables, after controlling for the debt-export ratio, since the structural variables should help to account for how much of any given amount of debt was acquired on grounds of intertemporal optimality, and also how effectively the country was able to respond to the rise in world interest rates.

Our strategy in this paper is to develop a basic statistical model of debt rescheduling that links reschedulings to key structural characteristics of developing countries: trade regime, income inequality, share of agriculture in production, etc. In section 2, we introduce the basic statistical models and the key explanatory variables. In section 3 we present the empirical estimates of the basic models. In section 4 we explore the robustness of the statistical results by considering additional candidate variables in the key regression equations. In section 5, we discuss the implicatio...

Table of contents

• Cover
• Title Page
• Copyright Page
• Table of Contents
• Introduction
• The Balance of Power in Nineteenth-Century South America: An Exploratory Essay
• Economics and Differential Patterns of Political Integration: Projections about Unity in Latin America
• The Structure of Dependence
• The Rise and the Decline of Latin American Economic Integration
• Manipulating International Commodity Markets: Brazilian Coffee Policy 1906 to 1962
• Dependency: A Critical Synthesis of the Literature
• Petroleum Policy in Venezuela: Lessons in the Politics of Dependence Management
• Multinationals, State-owned Corporations, and the Transformation of Imperialism: A Brazilian Case Study
• Consensus and Divergence: The State of the Literature on Inter-American Relations in the 1970s
• Interstate Conflict Behavior and Regional Potential for Conflict in Latin America
• State Institutions, Ideology, and Autonomous Technological Development: Computers and Nuclear Energy in Argentina and Brazil
• The Debt Crisis: Structural Explanations of Country Performance
• Classes, Sectors, and Foreign Debt in Latin America
• The United States and Latin America in the 1960s
• World Economic Cycles and Central American Political Instability
• Preempting Revolutions: The Boundaries of U.S. Influence
• Acknowledgments