Chapter 15
Trade and Policy Reform in Latin America
◼ Outline
Introduction: Defining a “Latin American” Economy
Population, Income, and Economic Growth
Import Substitution Industrialization
Origins and Goals of Import Substitution Industrialization
Criticisms of Import Substitution Industrialization
Case Study: ISI in Mexico
Macroeconomic Instability and Economic Populism
Populism in Latin America
Case Study: Populism in Peru, 1985–1990
The Debt Crisis of the 1980s
Proximate Causes of the Debt Crisis
Responses to the Debt Crisis
Neoliberal Policy Reform and the Washington Consensus
Stabilization Policies to Control Inflation
Structural Reform and Open Trade
Case Study: Regional Trade Blocs in Latin America
The Next Generation of Reforms
Case Study: The Chilean Model
96 Gerber • International Economics, Seventh Edition
◼ Learning Objectives
After studying this chapter, students will be able to:
15.1 Describe the strengths, weaknesses, and reasons for import substitution
industrialization.
15.2 Explain the strategy and performance of economic populism.
15.3 Give the main reasons for the debt crisis of the 1980s and analyze its relationship
to ISI.
15.4 Discuss the goals of economic policy reforms that began in the later 1980s.
15.5 Explain why some Latin American leaders have become impatient with
Economic policy reforms.
◼ What Students Should Know after Reading Chapter 15
Recent Latin American economic experiences cover most of the material in the text, making it an excellent
arena for bringing together the interplay of trade, finance, and integration issues of Chapters 1 through 14.
The goal of both this chapter and the next two is to provide case studies that demonstrate the utility of the
earlier material. It begins with an orientation to the countries, population, and GDP of Latin America.
Chapter 15 proceeds historically from the mid-twentieth century, describing in turn the retreat from the
world economy through the adoption of ISI policies, the appearance of economic populism and the
resulting macroeconomic instability, the debt crisis, and the policy reforms of the 1980s and 1990s. This
chapter does not argue that ISI caused the economic failures of the 1980s, but that it did produce
manufacturing sectors that were less able to respond to the failures brought on by unsustainable
macroeconomic policies. The long-term disadvantages of inward-looking policies are most clearly seen in
economic history of Latin America in the 1980s.
Chapter 15 Trade and Policy Reform in Latin America 97
◼ Assignment Ideas
1. The very recent past in Latin America suggested at least the possibility of a swing back toward
populism. Students can research this question and decide whether current populism in Latin America
is similar to past populist movements, especially by comparing economic policies. Candidates for
populist leaders include Chavez (Venezuela), Correa (Ecuador), Ortega (Nicaragua), Morales (Bolivia),
Kirchener and Fernandez (Argentina), and Zelaya (Honduras). Perhaps most notably is the way Lula
(Brazil) confounds this category.
◼ Answers to End-of–Chapter Questions
1. What were the main characteristics of economic growth in Latin America from the end of World
War II until the debt crisis of the 1980s?
Answer: The text characterizes growth in Latin America as (1) inward oriented, (2) unequal in the
distribution of its benefits, and (3) unstable. Growth overall was adequate to good in most
countries, at least until the 1970s (Table 15.3). The inward orientation of growth was a
result of import substitution industrialization policies that targeted the development of
2. What is import substitution industrialization? Explain its goals and methods.
Answer: ISI is an economic development strategy that uses industrial policies to target industries
producing import-competing goods. The goal is to develop the industrial capacity of the
economy. Industrial policies are targeted on import substitutes because it was believed
that declining terms of trade would create shortages of foreign exchange and constrain
98 Gerber • International Economics, Seventh Edition
3. What are the main criticisms of import substitution industrialization? Did ISI fail?
Answer: The text describes five main criticisms. These are (1) misallocation of resources when
governments make production decisions, (2) the constant tendency toward overvalued
exchange rates, (3) urban bias, (4) a worsening of income inequality, and (5) widespread
rent seeking.
Government involvement in production decisions meant that business criteria were not
used to make allocative decisions. Even if they did not nationalize firms, they still were
4. Describe a typical cycle of economic populism. Why does it often leave its supporters worse off than
before the cycle begins?
Answer: The typical cycle goes through phases. In the first phase, there is widespread
disillusionment with current policy, often as a result of a recession or a period of very
slow growth. In the second phase, populist governments begin a program of “reactivation,
redistribution, and restructuring.” In this program, the usual macroeconomic constraints
of budgets and foreign exchange are ignored. Budget deficits are run up—often through
the printing of money—in order to stimulate the economy. It often works. In the third
Chapter 15 Trade and Policy Reform in Latin America 99
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of inflation cause wage earners to give up all their gains. In the end, they may be worse
off than at the beginning of the cycle.
5. Explain how economic populist policies usually lead to overvalued exchange rates and large trade
deficits.
Answer: Populist policies involve large increases in government expenditures. These are usually
paid for by printing money because there is no market for bonds, and tax systems are
6. What were the proximate causes of the debt crisis? How did the United States and other industrial
countries respond?
Answer: One may argue that decades of ISI policies caused the debt crisis, but the immediate
causes were more direct. These included (1) a decline in oil prices, (2) a rise in world
interest rates, and (3) recessions in most of the world’s industrial countries. The first
factor reduced the creditworthiness of oil exporters such as Mexico and Venezuela and
7. Why did the Latin American debt crisis of the 1980s cause recessions in each country?
Answer: The requirements to service the debt by making interest payments and principal
amortization entailed large capital outflows and current account surpluses. This
8. What is the difference between stabilization policies and structural adjustment policies? Give
specific examples of each.
Answer: Stabilization policies are designed to stop inflation and eliminate large budget deficits.
The main way to implement these policies is through a cut in government expenditures.
100 Gerber • International Economics, Seventh Edition
9. What is neoliberalism? Why do some people consider it a negative term?
Answer: Neoliberalism refers to the stabilization and structural reform policies that would be
recommended in the Washington Consensus. It represents a return to the classical
liberalism of the nineteenth century, which stressed minimal government involvement in
the economy. In Latin America in the 1980s and 1990s it included the removal of
government from much of the economic decision making and a turn toward market-based
10. What was the content of Latin American trade reforms of the late 1980s and 1990s? How do the
actions taken relate to the desired goals?
Answer: Trade reform included (1) an opening of markets, (2) the creation of new trade blocs such
as NAFTA and the revitalization of old ones such as the Central American Common