Reinventing the State: Economic Strategy and Institutional Change in Peru

by Carol Wise

Overview

The political economic history of Latin America in the post-World War II era has largely been one of underachievement and opportunities lost. This all changed with the wave of market reforms that were implemented in the 1990s. However, the precise role of these reforms as an agent of change is still hotly debated. This in-depth analysis of the Peruvian case argues for an explanation that treats institutional innovation and state reconstruction as necessary conditions for the apparent success of the market in Latin America.
Exploring how state intervention has been both the cause of Latin America's economic downfall in the 1980s and the solution to its recovery, Reinventing the State analyzes three main phases of state intervention: the developmentalism that lasted until 1982, the state in retreat of the 1980s, and the streamlined state of the 1990s. Through a comprehensive examination of the Peruvian experience, the book explains the country's impressive turnaround from the standpoint of institutional modernization and internal state reform.
Written for a broad academic audience, the public-policy community, and the private sector, this book is also meant as a quick primer for any journalist, consultant, or private-sector analyst in need of an overview of the region's market-reform effort and how it has played out in Peru.
Carol Wise is Associate Professor, School of International Relations, University of Southern California.

Product Details

ISBN-13:	9780472113163
Publisher:	University of Michigan Press
Publication date:	01/17/2003
Series:	Development And Inequality In The Market Economy
Edition description:	New Edition
Pages:	304
Product dimensions:	6.00(w) x 9.00(h) x 1.10(d)

About the Author

Carol Wise is Associate Professor, School of International Relations, University of Southern California. She specializes in political economy issues as they relate to the development process in Latin America, with a focus on Argentina, Mexico, and Peru. She has written on trade integration, exchange rate politics, and the political economy of state reform in the region. Her edited books include Post-Reform Stabilization in Latin America: Competition, Transition, Collapse;Exchange Rate Politics in Latin America; and The Post-NAFTA Political Economy: Mexico and the Western Hemisphere. Professor Wise is currently coauthoring a book with Manuel Pastor entitled Twenty Years After: The Politics of Economic Transformation in Mexico.

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Reinventing the State: Economic Strategy and Institutional Change in Peru

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By Carol Wise

University of Michigan Press

Copyright © 2003 Carol Wise
All right reserved.
ISBN: 047211316X

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Latin America and the State-Market Debate: Beyond Stylized Facts

The literature on the political economy of development is rich with descriptions of government action over time and in-depth analyses of the causal relationship among state intervention, public policy, and development outcomes. In broad strokes, the story of the post-World War Two Latin American state has been portrayed in this literature as follows. During the heyday of ISI in the 1960s and 1970s, the state was cast favorably as the main protagonist in high-growth "miracles" such as those underway in Brazil and Mexico (Gereffi and Evans 1981). However, as Latin America fell on hard times during the debt-ridden 1980s, the state quickly became the culprit in explaining this downturn. Any notable economic turnarounds during the 1980s--say, in Chile--were attributed to the "miracle of the market" (Schurman 1996; Kurtz 2000).

Although the affinity for market reform had spread quickly through the region by the early 1990s, by the end of that decade its limits had also become apparent. The state's stock rose again, as the regressive outcomes of unbridled economic liberalization prompted calls for a more cohesive set of public policies to facilitate adjustment and correct for the many instances of market failure. As common wisdom would have it, the state appears to have come full circle: from its market-supporting role under a primary-export-led development model prior to the Great Depression; to its more encompassing "developmentalist" role during the post-World War Two era of ISI; to its widely hailed post-debt-crisis retreat from playing a direct role in the economy; and finally, back to the pre-ISI liberal state meant to bolster private initiative through the enforcement of property rights and the provision of basic public goods.

When this same phenomenon is examined empirically, there is some evidence to support this notion of the Latin American state having come full circle. Having peaked at an average of 24.3 percent of GDP for the region as a whole in the mid-1980s, public expenditure for the 1995-2000 period stood at about 16.6 percent of GDP--right on par with the 17 percent average registered during the 1970s (see table 3). There has been a similar convergence in public investment as a percentage of Latin American GDP (see table 4), which averaged 6.8 percent in the 1970s, compared to 5.4 percent in the second half of the 1990s. These patterns of holding the line on state expansion contrast with those of the industrial bloc countries, where public outlays continue to rise and are now easily 15 to 20 percent higher than those of Latin America (World Bank 1988, 44; World Bank 1997, 22). While one could surmise from the Latin American trends that policy makers finally came to their senses and reined in state expansion, these data also raise some intriguing questions.

First, if public-spending and investment levels in Latin America have circled back to their levels of two decades ago, and if these coefficients have been consistently lower than those in the industrial bloc, what was so problematic about these trends in the first place? Obviously, there is more to measuring the economic presence of the state than the figures just cited; for instance, the overall regulatory framework and the share of GDP captured by SOEs must also be included in any such assessment. Nevertheless, time-series data on the Latin American public sector from 1960 to 2000 seem to throw cold water on the "weight-of-the-state" argument that has underpinned so much of the market-reform drive in the 1990s. These trends also raise the possibility that the state has taken too much of the blame for the policy failures that erupted in the wake of the 1982 debt shocks.

A second question concerns the loose correlation between espoused development strategies and empirical trends in the Latin American state sector. How is it that public spending and investment as a percentage of Latin American GDP are roughly equivalent for two periods that could not be more different qualitatively--that is, the heavy-handed developmental state of the early 1970s versus the reticent, streamlined state of the late 1990s? Not only are these continuities counterintuitive, but they also suggest the extent to which the state-market debate has fallen prey to ideological posturing and stylized facts. The Chilean case, where high growth rates and deep market reforms have coexisted quite compatibly with a strong state presence, underlines the need for more flexible thinking on this subject.

A third question has to do with policy outcomes. In the face of fairly uniform approaches to market reform, how do we explain the diverse political-economic outcomes that have emerged since the revival of growth and investment flows to Latin America in the 1990s? How is it, for example, that Chile has grown twice as fast as Mexico--the country with the second-longest market-reform track record in the region--over the past decade? Or how is that Peru, a country devastated by guerrilla insurgencies, debt default, and natural disasters as recently as a decade ago, outpaced Argentina and Brazil in terms of its GDP share of exports and investment during the 1990s? Such variables as the shadow of the past, differences in the pace and timing of market reforms, and a country's ties to the international economy must all be taken into account.

But the one set of variables that differs most across these cases is the institutional dimensions of the state and the nature of the state's ties to civil society. As a number of authors have pointed out, the gaps between expressed policy preferences, concrete government action, and actual development outcomes are best understood by studying the broader institutional and societal context that frames the reform process (Evans, Rueschemeyer, and Skocpol 1985; Sikkink 1991; Evans 1995; Tendler 1997; Bresser Pereira 2000). Despite the apparent continuities over time in the levels of government economic presence, when viewed through this institutional lens, the state-societal dynamics that underpin the Latin American public sector of the late 1990s are worlds apart from those of the pre-1982 era.

Together, these questions form the basis for this chapter. In exploring them I draw, first, on empirical data that track state-sector trends and economic performance in Argentina, Brazil, Chile, Mexico, and Peru during the three development phases mentioned earlier: (1) the ISI/developmentalist era, which for reasons of data availability I treat here as the time period from 1960 to 1980; (2) the decade of economic retrenchment and state retreat that marked the 1980s; and (3) the era of market reform and state streamlining that was well underway by 1990 in all five countries. Second, I rely on institutional analysis as a means for understanding differences in economic performance among these five countries in the prereform period (prior to the 1982 debt shocks) and in the wake of implementing ambitious market reforms.

In this chapter, and throughout the book, institutions are treated in the classic sense, as those formal and informal rules that shape the behavior of individuals and organizations in civil society (Oliver Williamson 1985; North 1990; Burki and Perry 1997). At the same time, I take a more concrete approach to institutional analysis that considers the coherence of the bureaucracy, the delegation of decisional and operational authority, and the kinds of instruments that policy makers have at their disposal (Ikenberry 1988; Keefer 1995; Graham and Naim 1998). From the standpoint of institutional change the bottom line, as aptly summarized by Adam Przeworski (1999, 15), is to encourage "the state apparatus to do what it should while impeding it from doing what it should not."

The Latin American State: From Developmentalism to Debt Shocks

The Political Economy of State Intervention, 1960-80

With the advent of the 1982 debt shocks, the debate over economic development and structural reform in Latin America suddenly centered on the numerous shortcomings of statism as it had evolved over the post-World War Two period. One line of criticism pointed to the bloating of the public sector under the impulse of foreign borrowing in the 1970s and to the erosive effects of rampant state participation on economic growth and income distribution (Balassa, Bueno, Kuczynski, and Simonsen 1986; Edwards 1995). A second criticism stemmed from the comparative success of the East Asian states, as the multilateral institutions were particularly insistent that Asia had effectively avoided the debt crisis through its reliance on a market-led development model over this same period (World Bank 1983). While the crucial role of the state in fostering a high-growth export-led model and more equitable patterns of income distribution in East Asia was subsequently acknowledged (Amsden 1989; Wade 1990; World Bank 1993a), the notion that Latin America's problems stemmed from the weight of the state in the economy remained firmly embedded in ongoing policy debates. The result: a growing chorus of doubters who held that the Latin American state should step back and assign the task of economic development to the private sector and to market forces (Glade 1986; John Williamson 1990).

What light do the time-series data on the Latin American state sector shed on these debates? Ideally, in answering this question we would want to measure the presence of the state sector over time in terms of the extent to which government activities have transformed the political economy and altered the behavior and economic status of individuals and firms. On this count, public expenditures and investment levels tell only part of the story. The rest has to do with the effect of state regulations, patterns of macroeconomic policy making, and other indirect ways in which the state intervenes. For the lack of any single measure that captures these direct and indirect influences, each will be reviewed in turn.

Direct state intervention

Tables 3 and 4 present various measures of direct state intervention: public expenditures and revenues, the public-sector deficit, government debt, public and private investment, and the SOEs' contribution to GDP. As table 3 shows, the link between state largesse and the region's external borrowing spree of the 1970s is less robust than the critics would have us believe. For example, the first column in table 3 confirms that the public sector had asserted its economic presence well before the 1970s (Fishlow 1990). For four of the five countries in table 3, the period from 1960 to 1980 includes the first ISI phase of producing light manufactures behind high tariff walls, as well as a second developmentalist phase based on a combination of import substitution and the promotion of heavy industries (autos, steel, petrochemicals) geared toward exports. Chile was the one exception to this trend. Upon the installation of a military regime in 1973, Chilean policy makers jettisoned ISI and embraced a staunch market strategy for the duration of the military's seventeen-year reign. While the Chilean state still maintained its strong presence in the economy, this redirection of public resources into market-supporting endeavors was the harbinger of a more generalized regional trend that took root post-1982.

As private loans on international capital markets became increasingly available to these middle-income borrowers through the 1970s, there was indeed a tendency toward higher public spending. In relative terms, public-spending levels rose in varying degrees in all five countries from 1960 on; yet, in absolute terms, Latin America's average level of public spending as a percentage of GDP still paled next to that of the industrial bloc countries. Take the example of the United States, a country widely considered to be the least interventionist of this group: U.S. public spending as a percentage of GDP stood at 28 percent in 1960, compared to 16 to 19 percent in Chile or Peru-- those countries with the highest levels of state spending at this time. In 1985, this same figure for the United States was 37 percent, versus Latin America's average of around 24 percent (World Bank 1988, 44). Thus, it appears that state expansion per se was less the problem in Latin America during this period than was the tendency to rely on debt financing to cover a growing public-sector revenue gap.

The universal increase in government-held debt after 1970 reflects two key developments. First was the deterioration of public finances. Although state budgets were generally in deficit throughout the post-World War Two period in Latin America, these deficits accelerated sharply after 1970 (Stallings 1987, 362-63). While tax collections did not collapse entirely, external borrowing made it all the easier for most states to avoid the political conflicts commonly associated with fiscal reform. Second was the way in which these borrowed funds were put to use. Individual country experiences indicate a variety of destinations, including some combination of government consumption (the costs of the state bureaucracy), social transfers, fixed investment, and the financing of capital flight from the region.

As table 4 shows, the link between public investment and governments' ability to borrow was a direct one. In every country but Chile, public investment as a percentage of GDP peaked during the late 1970s or early 1980s, then gradually declined during the following decade of capital scarcity. Chile differed only to the extent that this same cycle occurred earlier, as public investment reached a high during the statist administration of President Salvador Allende (1970-73) and contracted in the period following the debt crisis. Apart from these continuities, individual country experiences indicate considerable differences in how borrowed funds were invested (Larrain and Selowsky 1991, 309-10).

For instance, in Brazil, Mexico, and Peru, governments borrowed to support manufacturing and infrastructure investments; in Argentina and Chile the private sector borrowed to participate more strongly in finance-related activities. In Argentina, Chile, and to a lesser extent Mexico, the explosion of government-held debt post-1982 reflects the degree to which the public sector was called upon to rescue private investors in the throes of the debt crisis. Nevertheless, in the end, Brazil, Chile, and Mexico are considered to have invested these borrowed funds fairly well, while Argentina and Peru did not (Frieden 1991, 74-80). As the following chapters will show, the lost opportunities from debt-backed consumption, versus borrowing for productive investments, emerge as a major theme in the Peruvian case.

The SOEs constitute the final measure of direct intervention and an essential component for understanding the changing economic role of the Latin American state during the developmentalist era. While the SOEs have frequently been singled out as the prime institutional outback for rent-seekers and venal bureaucrats, the disparate trends concerning the SOE share of GDP that appear in table 4 make it difficult to fully pin the blame on the SOEs for the region's economic disappointments. Two interlocking explanations account for the erratic pattern of SOE presence in the Latin American state sector.

First is the genuinely productive role that the SOEs have played in some countries in areas such as transportation, energy, and mining, where economies of scale and overhead costs simply surpass the resources of private entrepreneurs (Hirschman 1967; Glade 1986). For example, Chile's disproportionately higher share of SOE activity can be accounted for largely by state dominance of all aspects of copper production. There are also cases like Brazil, where SOE-sponsored infrastructure and other productive investments have succeeded in fostering the growth of downstream private enterprises (Trebat 1983).

The second explanation brings us closer to understanding how the evolution of the state-enterprise sector has been problematic. Along with the oft-cited inefficiencies related to subsidies and the pricing policies of SOEs (Glade 1986), greater access to foreign loans encouraged states to haphazardly assume a more entrepreneurial role through the creation of public companies.



Continues...

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