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‘Don't retreat on reform’

Argentina´s downward spiral has produced a great deal of soul searching among the development community. How could a country that seemed to have it all—including seemingly sound economic policies—have fallen so far so fast?

Argentina’s troubles are also prompting debate in other Latin American countries at a time of deep disillusionment with liberal economic policies. In a recent poll in Latin America, 62 percent of respondents had a very low opinion of the wave of free-market reforms and privatizations that characterized the 1990s. The polls also found that two out of three Latin Americans are dissatisfied with the results of democracy, and only half believe that democracy is the best form of government.

The poll data was presented in a paper co-authored by Eduardo Lora, principal advisor of the IDB’s Research Department, which notes growing dissatisfaction with economic reforms in recent years, especially among the middle classes. While Lora understands the disappointment and frustration, he argues that the region’s countries would recover more quickly if they don't abandon economic and political reforms, but rather strengthen and improve them.

Lora recently answered questions from IDBAmérica on what he sees as the major reform-related issues confronting Latin America and the Caribbean.

IDBAmérica: What is the main political challenge facing the region today?

Lora: I would say maintaining democracy. One of Latin America’s major achievements during the 1980s and 1990s was to move away from the military and nondemocratically elected regimes that had previously ruled most of the region’s countries. It would be very dramatic indeed if the current economic crisis were to give new life to these authoritarian regimes. A main challenge for Latin America is to strengthen its democratic institutions.

IDBAmérica: People wonder whether the liberal economic policies adopted by Latin American countries in the 1990s were “all pain and no gain.” In the face of criticisms, will governments return to the old policies of central government control and intervention?

Lora: Judging from past history, retrenchment seems unlikely, since the greatest reform periods have always taken place in times of crisis. But the current discontent could cause slippage in the reform process. The probability that this will occur will decrease to the extent that a rapid and sustainable solution can be found for Argentina’s problems, and that these problems are prevented from spreading to other countries.

In this regard, it is very important to keep in mind which reforms worked, and which ones did not work and why. The most important conclusion we can draw from studies on this matter is that structural reforms have proven much more effective in the countries with a strong rule of law. Our own analyses have also shown that Latin Americans are particularly opposed to privatization and other reforms when they perceive governments to be corrupt. As a result, improving the financial transparency and accountability in Latin America’s public institutions must be a foremost goal.

IDBAmérica: You continue to argue that regional economic integration is crucial to the region’s economic recovery, but many people believe trade liberalization and globalization are at least partly to blame for Latin America’s current problems. Is integration still the answer?

Lora: Absolutely. Our foremost goal must remain the creation of the Free Trade Area of the America (FTAA). Not only will the FTAA increase specialization and deepen trade links, but it will also lead to institutional modernization, improvements in productivity, and make the region more attractive for foreign direct investment.

Most of the hemisphere’s countries remain highly committed to the FTAA. But in some countries, recession, unemployment, and sudden shifts in exchange rates could very well dampen integrationist enthusiasm and give rise to protectionist pressures. The challenge will be to maintain momentum in the hemispheric negotiations, and assure that sub-regional initiatives converge into a single hemispheric free trade area.

IDBAmérica: In what other ways could the region’s countries more effectively cooperate?

Lora: Financial integration should also be high on the agenda. A key precondition is the development of the needed institutional framework, including harmonization and integration of the regulatory system.

Tax integration is also important, because the tax base for the value added taxes that many Latin American countries rely on is being eroded by the Internet and the globalization of commerce. Tax harmonization can also help to counteract the tendency of some countries to compete for foreign direct investments by granting special tax treatments that erode the tax base.

Finally, infrastructure integration efforts, such as the Plan Puebla-Panamá and the South American Infrastructure Initiative, are essential for deeper regional integration and specialization. They will promote the region’s competitiveness as well as distribute the benefits of economic development to more people.

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