Today, as in the past, public debate can resort to history in the quest for policy lessons. The COVID-19 crisis is prompting governmental action to meet the needs of large swathes of society and achieve rapid economic recovery. This is adding further pressure on public finances. However, while major stimulus packages are to be implemented in several rich countries, most developing and emerging economies do not have the fiscal capacity to provide similar amounts of financial support.
This challenging situation will require some form of international co-operation. History tells us that government intervention may be necessary to accelerate recovery in the aftermath of an economic crisis. The availability of funds and the rapid resolution of potential debt disputes are two major factors that can influence a state’s capacity to react. Previous experiences of economic crises and periods of financial distress also show that the involvement of private creditors and governments from capital exporting countries may further accelerate recovery. A brief narrative of two of the most important episodes of economic crises in Latin America is illustrative. In one case, domestic fiscal policies followed by comprehensive debt management facilitated a swift recovery. In a second case, inadequate domestic and multilateral responses to situations of financial distress generated excessive socio-economic costs.
A first episode of a major economic crisis was the Great Depression of the 1930s. In the decade preceding the crisis, Latin America witnessed an increased arrival of external funding which was used to finance new infrastructure and to promote agricultural exports. While the economic performance of each country differed, the onset of the 1929 crash led to a contraction of international trade and to capital outflows. Average annual GDP fell by 5.1% between 1929 and 1931, with Chile experiencing one of the biggest falls (-17%). Most Latin American countries defaulted on their public debts, in tandem with most governments in Europe. Despite the crisis, several public policies were introduced to support economic activity. Among them, the introduction of credit facilities by central banks and the establishment of national development banks. This strategy was combined with proactive exchange rate management and the state intervening in different sectors, occasionally leading to the nationalization of industries. As a result, Latin America accelerated the pace of industrialization and economic recovery. To some extent, the interruption of debt service, de facto a kind of debt relief, liberated financial resources that were channelled to productive sectors and to social expenditure.
By the late 1930s, Latin America had recovered under a new economic paradigm, prioritizing industrialization policies and conceding a more relevant role to the state. In certain cases, international trade between Latin American countries and the US resumed an expansionary path. The Second World War served as an incentive to accelerate negotiations between private investors –organized in committees of bondholders– and Latin American borrowers. This was done under the auspices of the US government that intended to boost co-operation with Latin American governments to have ready access to raw materials. In the 1940s, a wave of permanent debt settlements emerged. Even if private capital markets did not offer a source for additional funding, loans from the Export-Import Bank of the United States and later also from the World Bank were offered and conditioned upon the existence of such debt agreements. In return, bondholders assumed considerable haircuts on their claims.
The second episode was the debt crisis of 1982. High volumes of government loans granted by international commercial banks characterized the years preceding this crisis. Latin America exhibited high rates of economic growth, and foreign capital served to foster both capital and current public expenditure. As external conditions became unfavourable at the beginning of the 1980s, major macroeconomic imbalances triggered repayment difficulties in many developing countries. The rise in international interest rates increased debt-servicing costs, while a general deterioration in terms of trade and a fall in external demand reduced the availability of foreign exchange.
The resolution of the 1982 debt crisis raised a lot of criticism from scholars and policymakers. Its consequences are now considered a major factor that led to the infamous “lost decade”, during which economies experienced zero or even negative growth for at least seven years. Poverty rates and inequality also rapidly deteriorated, ending several decades of continuous improvement of those indicators. The negotiations involved several actors, and lending banks were organized through national advisory committees to facilitate coordination. The strategy followed at the onset of the crisis led to a process of debt reschedulings that did not alleviate the pressure on Latin America’s public finances. Furthermore, the conditions that came with the IMF’s involvement in the debt negotiations were directly aimed at achieving a massive reduction of public expenditure and promoting liberalisation policies. As a result, governments were obliged to introduce austerity measures, which also affected public investment. In a context of falling commodity prices and sluggish global growth rates, external conditions were also unfavourable to a rapid recovery. For instance, average real GDP growth rates between 1982 and 1989 were negative in Argentina, Peru and Uruguay, and close to zero in Mexico and Venezuela.
The now well-known Brady Plan, promoted by the US government and multilateral organizations, was innovative to the extent that it finally introduced a certain amount of debt relief and was conditioned upon the implementation of policies aiming at fostering economic growth. This plan – whose creditors’ participation was initially conceived as “voluntary”, but became compulsory in practice – offered banks a “menu” of options that best adapted to their interest and individual position. In practice, the plan introduced the possibility to exchange bank loans for new bonds whose value implied a debt reduction either on principal or on interest payments, while a third option required that banks contribute with additional capital depending on their long-term exposure to the country. Bonds were guaranteed by zero coupon bonds issued for that purpose by the US treasury. In the case of Mexico, the purchase of those bonds by the government was partly financed by loans from the IMF and the World Bank.
The Brady Plan marked a new point of departure for many countries. It provided a breathing space to some Latin American governments, allowing them to foster public investment and economic growth. In certain cases, and this was also recognized by US authorities, the outcomes of the Brady Plan were expected to consolidate democracy in Latin America, and to ease social tensions that had emerged the decade before. Finally, the Plan also allowed governments to access private capital markets under improved borrowing conditions.
The historical perspective presented above draws some lessons to face public finance challenges in the current context of the COVID-19 crisis. First, postponing policy action to solve public finance difficulties implies high socio-economic costs. A clear example is the impact of the long resolution process of the 1980 debt crisis on Latin American countries. Second, while policy support and co-operation across countries is necessary, the involvement and coordination of private creditors is helpful to reduce uncertainty on access to capital markets. Third, conditionality matters considerably for medium-term socio-economic trends, and should focus on the most pressing needs, including policies to boost economic recovery. In a nutshell, historical experiences of debt crises show that to mitigate the impact of COVID-19 on citizens’ wellbeing, rapid action, well-coordinated mechanisms with different actors, and clear definition with developing countries of the conditions to solve public finance problems, are necessary.