Latin America isn’t at risk of a 1980s-style crisis (but an era of missed opportunities looms)

Food lines that stretch across multiple city blocks. Spiraling unemployment. Out-of-control inflation. Unsustainable debt. These issues, which traumatized many economies across Latin American in the 1980s, continue to reverberate today and, given current economic conditions, you could be forgiven for fearing that history is about to repeat itself.

However, the region’s biggest risk at present is not another “lost decade” fueled by financial crises, but rather a decade of missed opportunities. 

The debt crises of the 1970s and 1980s were searing experiences that find an echo in today’s troubles. Then, as now, Latin American countries had large debt loads. Then, as now, the global economy experienced unique macroeconomic shocks that sent inflation soaring (the Arab oil embargo then; the pandemic and Ukraine war now). And then, as now, central banks around the world – especially the US Federal Reserve – were raising rates to fight inflation.

There is one key difference, however, between then and now: Latin American countries are much better prepared to react to these shocks today than they were four decades ago , owing in no small part to the enormous improvements that have been made in economic and financial policy across the region. While the U.S. Fed has been accused of being “behind the curve,” most Latin American central banks have moved quickly to quell inflation and guide their economies back to target inflation levels.

Moving early to raise rates has helped keep exchange rates in check. In the past, Latin American economies were beholden to a vicious cycle of depreciation-inflation-depreciation: currencies would lose value, which would lead to inflation, which would lead to them further losing value as confidence in macroeconomic management deteriorated. That cycle is less of a risk today in most Latin economies. It’s true that some currencies have depreciated markedly in recent months (e.g. the peso in  Chile and Colombia) but feedback loops through inflation appear tamer than in the past.

Beyond the recent monetary firefighting that the region has thus-far undertaken, with relative success, Latin American economies have also undergone structural improvements that make them more resilient today than during the 1980s. 

For example, the establishment of independent central banks, the adoption of floating exchange rates and inflation-targeting regimes, and the strengthening of policy institutions have all bolstered most Latin financial systems. With more predictable inflation and stable currencies, local debt markets have become the main source of government funding, creating greater stability by reducing reliance on dollar-denominated debt (which is vulnerable to exchange-rate shocks) and short-term financing. This explains why the larger economies in the region have been able to implement large countercyclical programs to protect families and firms from the worst impacts of the pandemic crisis – a fiscal response that would have been unthinkable in recent decades.

Furthermore, back in the 1980s many Latin American firms and public institutions lacked access to domestic financial markets - the global banking system was the predominant source of funding for governments, meaning the ups and downs in foreign financial markets made it harder for governments to control their own fiscal policy.

That has changed: local capital markets have developed in recent decades, returning fiscal policy control to governments. Greater fiscal control has meant a greater ability to effectively confront shocks like the pandemic (albeit in different ways among Latin American countries). The combination of greater global market access and more developed domestic markets means that private firms have far more mechanisms to access finance and hedge their risks than they had 40 years ago.

In short, we are optimistic about most of the region’s ability to avoid crisis.

That’s not to say the coast is clear. Although Latin America is not likely to experience massive economic contraction or spiraling unemployment, it does risk prolonging the economic stagnation of the last decade. 

Since the commodity boom fueled by China's rapid economic expansion in the first decade of the 21st century fizzled out, countries in Latin America and the Caribbean have not found a comparable engine of growth. Per-capita GDP growth in the region has, on average, been close to zero in the last decade – the lowest since the end of the 1980s. Tepid growth should not be the norm.

Countries in Latin America and the Caribbean trade little with other economies (especially in the cases of Brazil and Argentina). That means domestic market leaders do not feel the pressure of international competition to innovate. Business conditions are not as conducive to entrepreneurship as they could be. Consumer regulation remains unnecessarily burdensome. School systems still produce disappointing educational results, particularly for children from low-income families – reinforcing historical patterns of high inequality. The absence of a region-wide market that permits the free movement of labor obstructs the efficient allocation of resources and impedes greater economies of scale.

There is a lot at stake here. Few incentives to innovate and inadequate human capital are curbing ingenuity and preventing the region from becoming the home of the next great disruptive invention. The resulting low productivity growth also limits poverty reduction, hampers inclusion, and increases the need for welfare.

This hard-won progress in macroeconomic management is also vulnerable to reversals, as sluggish economic development creates a breeding ground for social unrest and populist ideas. The growth in debt levels—attributable in part to the pandemic response—will now need to be reined in gradually, at a time when polarization and social unrest make fiscal adjustment challenging.   

These outcomes are completely avoidable. Policymakers should act now to prevent them.