CHAPTER 3: LATIN AMERICAN PUBLIC DEBT CRISIS IN THE 1980S
3.1. Causes of Latin American Public debt crisis
With the large scale and the several consequences that it caused, the Latin American crisis has always been in the scope of research by many economists and politicians, there have been many causes given by the researchers to explain this crisis. In this essay, we just list and summarize some of the main reasons that we think they had the greatest impacts on the public debt crisis in Latin America.
3.1.1. Internal causes
*Inefficient economic structure and the foreign capital dependence
In the 1980s, Latin American nations were less-developed countries with GDP was about 4014$/year. Their economic structures didn’t develop the same among different fields and their income primarily came from exporting oil. After two times the oil price skyrocketed, Latin America countries in general, especially Mexico, gained huge revenue and were evaluated to have strong potential in economic growth. However, in fact, due to the inefficient domestic economic model and the inappropriate administration in macro policy, those countries not only couldn’t reach the development expectations but also faced a significant setback and ended up to the public debt crisis. Their inadequacies in economic decisions derived from a big problem: the monopoly in process of moving up to economic market and making it work ineffectively. In the 1980s, major economic sectors in Latin American countries still were in the government protectionism, it eliminated the self-developed motivation of those fields so they grew slowly and usually made loans but didn’t consider how to use them effectively. In the same period, financial market in general and stock in particular in the area didn’t really advance so the firms ‘demand for loans at banks increased. Moreover, the inappropriate government’s management made state banks remain the low interest rate to protect the key sectors, which deviated completely to the law of supply and demand, it was the reason why demand exceeded supply. In order to satisfy this demand, the governments forced to stand out and borrow foreign capital. It was not the only fault in economic policy administration of Latin American nations, the misleading investment in industrialization was the biggest mistake, which leaded to public debt crisis. Due to the weak economic model, governments decided to invest in industrialization. In order to do it, they must import materials and equipment from foreign countries. It was the reason why Latin American nations were from oil trade surplus to trade gap, which made current account deficit and those countries were forced to borrow foreign capital to cover government purchasing.
However, the industrialization development in the market which was not free with too much intervention of government had no effect in improving the economic area. Looking at the chart below, we can see clearly in the late 1970s and early 1980s, after applying this industrialization model, economic growth in Latin American countries not only decreased
but also reached to negative growth, the trade balance also decreased. Thus unreasonable investment in industrialization failed to boost the economy but instead resulted in huge foreign debt.
Figures 3-1: Latin American external debt and reserve.
From the weak economic governance that led to high demand for foreign debt, Latin American countries became too dependent on foreign investment. Since World War II, the proportion of foreign investment in this region only fluctuated at 19%, but during the period 1975-1980 the investment rate increased to approximately 23% with the majority was short-term investments. And as soon as the economy showed signs of going down, but in the early 1980s, foreign investment capital also exited massively, making the rate of foreign investment decline significantly to 17% in the 1990s. Latin American accustomed to rely on borrowing; this was a shock for the Latin American economy, causing the risk of default to begin to rise. (See the figure below)
Figures 3-2: Latin American Total debt, Total debt service and Interest
*The impact of export deficit
As we said above, due to the demand of borrowing capital to cover government purchasing and for private areas, the public debt crisis in Latin American boomed, however, it was not the only reason. In the 1970s and 1980s, the income of Latin American countries mainly came from exporting oil. However, after the first shock of oil price, imported countries had trade protection policy, restricted import to increase domestic production and purchasing. Those actions made huge effect to the quantity of the oil exported of Latin American, especially Mexico.
Figures 3-3: Mexico Crude oil prices from 1861 to 2011.
The export of Latin American area not only was affected from international trade policy, but also suffered from high inflation in the early 1980s. The reason for the inflation was many countries’ currencies were based on the USD. When the USD increased because of the deficit situation in the US, Latin American countries’ currencies were pushed up accordingly. This situation was most serious in Mexico, the inflation ration in 1981 rose dramatically to 27%. The inflation had significant impact in exported products so the income from exporting decreased leading the current account deficit. The Latin American countries couldn’t depend on the income from foreign currencies to repay foreign loans. Consequently, the repayment of debt was more difficult and eventually a series of countries had to declare insolvency, the public debt crisis spread.
3.1.2. External causes
*The wrong investment decision of the Europe and the USA
The foreign capital poured into the Latin American made indirectly public debt crisis in this area. After the first shock of oil price, the OPEC countries had current account surplus. These countries brought the large amount of huge profit come from exporting oil to the bank system in the Europe and the USA. The investment destination of those banks
was Latin American area. The reason for this choice was that many Latin American countries were major oil exporters, which gained high profits. When the international banks just looked at the oil reserve of these nations and clearly, they had a lot of potential profit sources and could rank well in credit safety. However, the fault was that banks didn’t consider the foundation of economic structure and the development direction of these countries revealed the weakness in the lately 1960s. The evidence was that they had inappropriate micro policy and used loans ineffectively, didn’t have profit and eventually it leaded to budget deficit and insolvency. In addition, the idea that a country's government couldn’t be insolvent and the public debt was absolutely safe was not right, especially for countries that were still in the transition like Latin America. Because they didn’t considered carefully, they poured too much capital into this area and then immediately withdrew capital when seeing some signals of decline, which caused these young economies completely lose their ability to resist, making public debt crisis become bigger.
*The increase several times of real value of the loan due to the appreciation of the dollar.
Most public debts of Latin American countries were denominated in dollars with floating interest rates based on LIBOR rates. However, by 1978, the US budget deficit made the LIBOR rate rise from 9.5% to 16.6%. This pushed up the USD price, increased the real value of credits in USD, and also increased interest rates. It is the reason for the debt obligations of Latin American countries become more and more burdensome, leading governments to declare insolvency.