The Existing Structural Problems that Led to the Latin American Debt Crisis

The Latin American Debt Crisis of the 1980s (also known as the Lost Decade) was one of the most traumatic economic events in Latin American history. Before the 1980s, Latin American countries borrowed capital from foreign commercial banks to fuel their development. However, to soften the effects of the 1973 Oil Shock, the US Federal Reserve increased real interest rates. This increase led to a rapid rise of the real value of Latin American debt. In fact, by the 1980s, Latin America’s foreign debt amounted to nearly half of the region’s GDP. The crisis became evident when the Mexican government announced it could no longer service its debts in August 1982. Indeed, when foreign commercial banks halted the inflow of capital and demanded the repayment of existing foreign loans many other Latin American governments – including Brazil, Argentina, and Bolivia – also announced that they could not make payments on their foreign debts.

With no real method of repayment for their foreign loans, Latin American governments reached out to the IMF (International Monetary Fund) and World Bank for assistance. And as a result, they underwent Structural Adjustment Policies designed by the IMF and World Bank. 

Although relentless lending from foreign commercial banks was one of the triggers of the Latin American Debt Crisis, there was a more critical, structural problem in Latin America that had hindered the region’s economic development and ultimately led to the crisis. It was, in fact, the inability of the region’s governments to unify the industrialist and working classes behind the cause of national development that left the region so vulnerable to this economic disaster. This inability to unite the two classes originated from the structural problems of Latin American governments. 

These tensions between the working and industrialist classes emerged from the interaction of intra-political elites during the state-formation process. The Sociologist Tuong Vu identified that a nation formed through polarisation and conflict would have strong political unity, because political elites with similar ideology converged while eliminating their opposition. On the other hand, a government formed through the coalition and collusion of political elites tended to have a relatively weak political unity as such coalitions are maintained through conditions and government appeasements. If the government fails to satisfy either side of the coalition, the fragile system could break and lead to political chaos. Latin American governments were formed through a coalition of the working class and industrial classes. Thus, the region’s governments needed to use significant resources and create favourable policies to maintain the political coalition

Before the Latin American Financial Crisis, Latin American governments implemented large, inefficient and nearly-unconditional investments and subsidies to appease the industrialist class. Inspired by the manufacturing and export success of some Asian countries (mainly Taiwan and South Korea), Latin American industrialists pressured their governments to provide the capital to import the technologies and resources required to mimic the Asian model. Yet, while many of the Asian governments had incentivised private firms to improve their efficiency through conditions attached to their subsidies and support, Latin American governments failed to do so. To appease the industrialists, Latin American governments continued to subsidize and invest in inefficient firms that had no incentives to improve their efficiency without any sufficient returns for their investments. Thus, government deficits grew and some countries were forced to borrow from foreign commercial banks to bridge the gap between government revenue and spending

The Latin American governments spent more than even Europe did on large social safety nets in the form of in-kind transfers and social funds to appease the working class. Moreover, the government conducted inefficient small-sized infrastructure projects to provide jobs to low-skilled workers. However, they did not have sufficient government revenue to sustain the large social safety spending and infrastructure projects. This government spending only contributed to the borrowing of capital from foreign commercial banks

Furthermore, Latin American governments fixed their currencies at overvalued rates in an effort to appease both the industrialist and working classes. As the industrialists were importing technologies and resources to fulfill their ambition of mimicking Asian success, these overvalued currencies made imports cheaper. Similarly, overvalued currencies also appealed to the working class as many preferred higher quality foreign goods to domestic products. The industrialist and working class favoured the Latin American governments’ policies of maintaining overvalued currencies as it lowered the cost of foreign technologies, resources and foreign goods. However, to sustain the artificially fixed overvalued rates, Latin American governments had to use their foreign currency reserves which eroded their ability to pay their external debts. 

With large foreign debts, political coalitions to maintain and depleted foreign currency reserves, the region became extremely vulnerable to external shocks. The increase of real interest rates by the US Federal Reserve provided the shock that triggered the Latin American Debt Crisis in 1982. Since Latin American lenders were commercial banks based in the United States, the real value of Latin American debt increased from $159 billion in 1977 to $315 billion in 1983.

Certainly the continued borrowing from foreign commercial banks was a problem that contributed to the region’s economic vulnerability. But ultimately, it was the pre-existing structural problems in Latin American countries that led to the inevitable economic crisis in the 1980s. 

Kipyo Do

Kipyo Do is a third-year undergraduate at King’s College London studying International Development. 

The featured image (top) is a 1983 photograph from the Biblioteca del Museo de la Memoria y los Derechos Humanos. The image is in the public domain.

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