In our interest in the economics of the so-called “first world countries,” we, most often than not, forget about several countries who we think are not relevant in global economics. We so occupy ourselves with the geopolitics of countries like the US, UK, and Europe, that most of us forget about the existence of an entire continent – South America. Or at least, we forget about their economic existence.

And why not? In the last 20-30 years, which countries from this continent have had such growth or development so as to become the centre of the world’s attraction? Or had such an economic history which can attract the curious from far and wide? Hence, it is the natural human tendency to move to other countries which have an interesting economic history and are in the centre of the current global economy.

But, if one takes a closer look, we can see how wrong we all are. At the beginning of the 20th century, Argentina had the world’s sixth highest per capita income. In the 1950s, the per capita income of the South and Central American economies was more than twice that of the Asian Tigers and other Asian economies. Today, the Asian tigers have all become developed economies while these economies have remained where they were – the development stage. What can be the reason behind such a dramatic fall? Surely, it must be one hell of a story (even though it would not be one that these economies would be too proud of).

It all started in the 1950s when the Latin American economies adopted a model which according to the world was not the best model for growth and development. They adopted the model of Import Substitution Industrialization (ISI) for growing and developing their economies.

Now, what is that?

Basically, the ISI model of growth is industrializing and developing the local industries by putting high tariffs and restrictions on imports. That is, the economy puts such high tariffs and restrictions on imported products that it is unable to import any product from the global market. This gives the local industries a chance to grow and develop as they have the entire domestic market demand to cater to. After a while, when these local industries become competitive enough to compete in the world market, the economy would reduce the import restrictions and tariffs and merge into the global economy. And this is what these South American economies basically did.

In the beginning, everything went smoothly and as planned. These economies were growing at an average rate of 6% per annum. The rapid industrialization was creating thousands of new jobs, creating demand for various commodities and providing multiple employment opportunities. Hence, it helped in the overall growth and development of the economy as well as in raising the standard of living of the people.

But problems began to hit soon. These domestic companies eventually realized that there was no competition from the international market which could put their existence in jeopardy. Hence, these companies saw no need to develop and innovate new products and services for consumers as they knew that consumers had no option but to come to them. Moreover, most of these were public sector companies which gave them the additional government backing if they ever ran into problems. Hence, with government always at their back at times of crisis, these companies had no intentions of spending funds on research and development to innovate on new and better-quality products, newer and better techniques of production and so on. Eventually, after a few years, the growth rate of these economies became stagnant. Moreover, the time never came when these industries became competitive enough to compete in the world market.

Then, the real crisis hit. In the year 1973, the oil shock caused by the OPEC cartel swiftly raised the prices of raw materials and commodities all across the world. In these South American economies too, the prices of raw materials started rising which increased the prices of the finished products. This started increasing the inflation rate. These local companies and industries were not able to support themselves and produce goods and services at low prices. Hence, they looked up to the government to financially support them.

The governments did what any other self-respecting government would do. They started taking loans from the international market (mainly US banks), as credit was too cheap and the interest rates were almost zero, to finance these industries. Their financing was on the presumption that these industries by now, and by the help of these loans, would be able to become internationally competitive so as to export these goods in the world market and earn profits to repay these loans. But, most of the loan amount went for consumption expenditure to help the citizens survive during this tenure of high prices and a very small amount was made available for these industries. Seeing that credit was too cheap, governments started borrowing excessively from the world market and before they knew it, the combined loan amount of the South and Central American economies reached USD 327 billion in 1982, as compared to USD 29 billion in 1970.

In the early 1980s, with a view of controlling inflation in the developed economies, the monetary policies of the US and Europe began to tighten. Paul Volcker, the US Fed Chairman, raised interest rates (which had once been negative in 1971) to 8% in 1981. This caused a worldwide recession as people started pulling out their investments from developing countries to invest in the US. Therefore, capital inflows almost came to a standstill in these South American economies. This sudden spike in interest rates put these economies into a debt trap and they soon realized that they would not be able to repay the interest on these loans, forget the principal amount. This is because the majority of their loans had gone for consumption expenditure and its industries were not competitive enough to compete in the world market to generate trade surpluses to repay these loans. Mexico was the first to give in and in August 1982, it declared that it would no longer be able to service its debt. Soon, other countries followed suit.

Being a hegemonic country, the US could not allow these economies to fail as the majority of loans were financed by US Banks. If these countries were allowed to fail, then it would have an adverse effect on the US economy as 6 out of these 9 banks would collapse. Therefore, with the help of the International Monetary Fund, the World Bank, and other agencies, they came up with the Brady Plan to help these economies revive. In the plan, the IMF, the World Bank, and other agencies agreed to provide sufficient funds to these economies to pay off their interests. They also restructured their loans to help them to pay off easily. In return, they were asked to restructure their economies, remove budgetary deficits and increase exports to repay their loans.

This step surely averted an immediate crisis, but it deepened the problem. As the industries of these economies were not competitive enough, they were not able to generate enough surpluses to pay off their loans. Therefore, they had to resort to other options such as cutting spending on infrastructure development, health, education and lay off employees for raising enough money to repay the loans. This resulted in high unemployment, steep declines in per capita income and negative or stagnant economic growth.

The South American economies witnessed a stagnant period of growth from the years 1980 to 1990. There was no rise in the citizens’ standard of living or in real GDP of these economies. If one looks back, it can be seen that the decade from 1980 to 1990 was the darkest phase in the history of these South American economies. However, it looks like light has, once again, dawned on these South American economies. Today, the South American economies have a growth rate of 5.5% per annum, which is the second largest in the world after South East Asian economies. These economies have become a hotbed for investment, attracting investors from all around the world, with countries like Brazil rising steadily to become the next economic superpower in the world.

However, the heights of success which these economies are reaching right now could have been achieved a lot earlier had it not been for the Lost Decade. Critics say that the Lost Decade pushed back the economic growth of these economies by at least two decades. Yet, the GDP of the entire South American economy today is close to USD 4 trillion, which is less than the GDP of Japan. Hence, even though the South American economies have done exceedingly well in these recent years, the continent as a whole has a long way to go before it can become a major economic contender and the centre of economic activity in the world.

Therefore, the one question that still lingers in the minds of critics all around the world is: in order to desperately save themselves during “The Lost Decade,” did these economies throw away the next two decades of potential high growth and development, which would have put them at par with the rest of the world, as payments to the US Banks?

By Abhishek Sancheti