In the fifth of a six-part series, Andrea Mandel-Campbell examines what went wrong with South America’s experiment with democratic and economic reform.

It wasn’t so long ago that sober-suited Wall Street bankers were falling over themselves to bankroll Latin America’s rising stars while its U.S.-educated leaders were being feted by the Washington elite and multilateral lending agencies.

These days, the bankers have abandoned the region’s five-star hotels and the easy money has also vanished.

With the exception of Mexico and Chile, much of the region is engulfed in the worst crisis since the 1980s, when debt default and widespread poverty earned the period the ignominious title of “the lost decade.”

Today, one country after another seems to be folding like a house of cards, with currencies plummeting, bonds sinking to default levels and desperate citizens rioting in the streets.

The region’s fragile underpinnings were first shattered by Argentina, which simultaneously suffered a devaluation, a banking crisis and the worst debt default in history. Six months later, the country faces a second default and more social upheaval as it continues to grapple with a banking freeze and political paralysis.

The crisis has sent shock waves through neighbouring Paraguay, which recently declared a temporary state of emergency, and Uruguay, once considered the Switzerland of South America.

The usually placid country has lost its coveted investment-grade status along with nearly half its bank deposits and two-thirds of its international reserves, prompting the besieged government to implement a partial banking freeze.

The potentially fatal blow, however, looms on the horizon. In the past two months, Brazil has watched its currency sink to all-time lows while its sovereign bonds are trading at exorbitantly high rates, sparking concerns of a debt default.

To stave off a possible balance of payments crisis, this month the International Monetary Fund agreed to provide Brazil with US$30-billion in additional funding. The IMF bailout, the third in four years, should help the regional powerhouse stabilize its currency.

Nevertheless, risk-averse investors remain jittery ahead of October presidential elections. If investors continue to be spooked, analysts warn it could spell the end for what remains of dwindling but all-important foreign investment into the cash-strapped continent.

“If Brazil defaults, it will probably be the last nail in the coffin for South America as an investment destination,” said Arturo Porzecanski, chief emerging markets economist for ABN Amro Inc. “We could very well be in another lost decade, we just didn’t realize [it] before.”

The culmination of five years of economic stagnation, the latest crisis has trapped leaders in a vicious cycle of low growth, indebtedness and unpopular spending cuts that have soured an already restive population on pro-market reforms.

It has also helped to push Latin America further behind in the global race to catch up with the developing world.

According to a report released this month by the United Nations Economic Commission for Latin America & the Caribbean, (ECLAC), economic activity in the region will shrink by 0.8% this year, after a scant 0.3% increase last year.

Leading the decline is Argentina, which is forecast to contract by a record 13.5% in this, its fourth consecutive year of recession. Even Chile, the region’s star, has halved growth forecasts to 2.6%.

“Latin America is negative across the board,” said Gillian Manning, an economist at TD Economics. “It is the weakest sector of the world economy and raises the most cause for concern.”

Fifteen years ago, many Latin American countries knew exactly where they were headed, as they shed their military dictatorships and closed economies to embrace democracy and open markets.

The radical conversion fuelled growth and tamed hyperinflation. In Argentina, which vigorously adopted market-friendly reforms, inflation went from 5,000% to 1.6% in a decade.

Foreign investment flowed in with the privatization of state monopolies, crumbling infrastructure was modernized and living standards improved. In Bolivia, for example, the percentage of the population living in poverty dropped from 86% to 58.5%.

Despite the initial success, sluggish growth over the past five years has exacerbated chronic high unemployment and pushed interest rates and inflation to unsustainable levels. Living standards, in turn, have deteriorated, with gross domestic product per capita declining 2% since 1997.

In Argentina, once the middle-class mecca of Latin America, half the population now lives below the poverty line, while in Venezuela, average per capita income has fallen 24% in the past 20 years.

“The combination of the collapse in income and high unemployment is generating extreme poverty that has never been seen before in Venezuela,” said Orlando Ochoa, a Venezuelan economist.

Much of the latest setback can be traced to the Asian financial crisis of 1997-98 and the collapse in worldwide commodity prices. Foreign investment has never rebounded while commodities, a key component of all Latin American economies, are 15%-25% below 1997 price levels.

The bleak situation has been worsened by the continuing meltdown in Argentina, the global uncertainty surrounding the U.S. economy and volatile stock markets.

Nervous investors are largely steering clear of the crisis-prone region — the most dependent in the world on foreign inflows of capital — turning it into a net exporter of foreign capital since 1999, says the UN agency.

The shortfall, made worse by low growth, is adding to many countries’ already heavy debt loads. Perhaps more crucially, it is exposing deep-rooted structural problems that until recently were papered over by foreign cash.

“The market volatility has created a giant magnifying glass to endemic, systemic problems that have hardly been addressed since colonization,” said Jerry Haar, senior research associate for the North-South Center at the University of Miami.

Much of the problem stems from the countries’ inability to generate enough capital internally. Domestic savings rates are abysmal and tax evasion is rampant — as high as 50% in some countries. Meanwhile, exports are lacklustre, making up only 10% of GDP in the case of Brazil.

The lack of domestic capital also failed to instill fiscal discipline, with most countries continuing to add to their already large budget deficits year after year. As a result, Brazil’s ratio of debt to GDP (which compares a country’s debt to the income it generates internally) has ballooned from 28.5% in 1994 to 60%. Ecuador, with a ratio of 80%, threatens to default on its debt for the second time since 1999.

With little ability to pay down the ever-growing debt internally, analysts say most countries have become over-reliant on unpredictable and volatile foreign inflows of capital to bridge the gap.

“When you have a very small pool of domestic savings, exports are a small share of GDP and you overspend like mad, you become hooked on foreign capital,” said Ms. Manning.

This scenario is particularly true of Argentina. Even during years of relative prosperity, the government continued to run fiscal deficits and take on new, largely foreign-denominated debt, to fund its spending spree. This made it especially vulnerable to financial crises in Mexico, Asia and Brazil, as nervous investors fled the market en masse and financing dried up.

At the same time, it was powerless to jump-start growth with a currency pegged to the U.S. dollar that left it unable to cut interest rates and depressed trade.

Nevertheless, for many, the key to Argentina’s downfall — and to the turmoil engulfing many of its neighbours — is more insidious and less quantifiable than pure economics. It is all about widespread corruption and political strife.

“The harsh truth is that Latin America is a collection of kleptocracies, of governments that steal,” said Larry Birns, director of the Council on Hemispheric Affairs in Washington, D.C. “It is one of the most corrupt regions in the world.”

No fewer than four former presidents are now living in exile. They include General Lino Oviedo of Paraguay, who allegedly ordered the assassination of his vice-president, and Peru’s Alberto Fujimori, who fled to Japan after his closest advisor was linked to bribery, drug trafficking and murder.

Ecuador is on its fourth president in three years and its fifth finance minister since January, 2000, when Gustavo Noboa, the current head of state, came to power in a bloodless coup.

Its most flamboyant ex-president, Abdala Bucaram, dubbed “Mr. Crazy” because of his aspirations to become a pop star, has been in Panama for the past five years after a series of corruption scandals during his six-month tenure.

Decades of corruption in Venezuela’s two-party system directly contributed to the rise to power of Hugo Chavez, a populist and bellicose former paratrooper, who, like his predecessors, has failed to diversify the economy and reduce its dependence on oil.

Instead, the autocratic ruler, who dreams of launching his own revolution, was forced to float the currency earlier this year — it plummeted 74% — while rampant overspending has raised indebtedness.

“Chavez is your stereotypical populist strongman who is just a by-product of a dysfunctional political system that is corrupt to the core,” said Miguel Diaz, director of the South America program at the Washington-based Center for Strategic & International Studies.

The leaders’ ineptitude and entrenched cronyism have often hampered the introduction of crucial institutional reforms meant to underpin the region’s pro-market policies. Instead, special interests stymied efforts to clean up the bureaucracy, politicians bowed to powerful labour unions and congresses failed to introduce regulatory regimes and property codes that gave adequate legal assurances to investors.

At the same time, corrupt judicial systems have been largely left untouched, and the all-important overhaul of creaking and distorted tax systems has been endlessly delayed by squabbling politicians anxious to protect powerful constituents.

“The reforms were not carried out to the degree necessary,” said Peter Hakim, president of the Inter-American Dialogue, a Washington-based think-tank. “The economies were very distorted and managed very badly and the reforms needed were very profound and very deep, and the fact is a lot was left undone.”

Pablo Breard, head of international economics for Scotiabank Group, said, “Without the rule of law it is impossible to achieve economic stability or long-term development.”

As a result, in the absence of reliable institutions, many a country’s fortunes are all too dependent on the ability of its president to steer a course through turbulent economic waters and curry favour with international investors and multilateral lending agencies.

Fernando Henrique Cardoso, Brazil’s President, is among Latin America’s most respected leaders. During his eight-year tenure, Brazil introduced a gradual series of reforms that helped rein in spending and privatized large swaths of the energy and telecommunications sectors that have become a model for the region.

But despite his attempts to build a solid institutional framework, Brazil’s economic health remains fragile. The prospect of the end of Mr. Cardoso’s mandate in January has investors and capital markets panicked.

While the two leading presidential candidates in the October elections come from left-wing opposition parties, both have pledged fiscal responsibility. However, their promises seem to have fallen on deaf ears as masses of spooked investors exit Brazil.

“When there is no confidence in the rules of the game, then everything rests on the shoulders of one man,” said Mr. Porzecanski. “And that’s a pretty precarious balance to keep.”

Andrea Mandel-Campbell, National Post, August 24, 2002