Avoiding Latin American Mistakes

Macroeconomic populism may be the easy way to run up political points, but it bequeaths an economic and political mess to future generations.

| Tue Jul. 11, 2006 3:00 AM EDT

Article created by The Century Foundation.

Events of the last week offer examples of struggles with a phenomenon that has been called "macroeconomic populism." Coined nearly 20 years ago to describe the political economy of policy making in Latin America, the idea applies today to political struggles in the United States as well as in our neighbor, Mexico.

In Mexico, presidential candidate Andres Manuel Lopez Obrador is rallying working people on his behalf with appeals to macroeconomic populism. Closer to home, on a less grand scale, the fight between Governor Jon Corzine and the state legislature in New Jersey is an example of an effort to confront populism.

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The term "macroeconomic populism" was coined in 1989 by economists Rudiger Dornbusch and Sebastian Edwards to describe a pattern they observed again and again in Latin America. Elected leaders would pursue popular policies, spending freely on programs and investments that appealed to low-income voters, running bigger and bigger budget deficits, without regard to the monetary or international payment consequences. Following a period of economic growth and rising incomes, inflation would take off, pressure on the currency would aggravate the domestic imbalances, and the leader would impose price and currency exchange controls. Eventually, the boom would turn into a bust as the fiscal profligacy of early years came home to roost.

The appeal of macroeconomic populism to elected leaders is that it provides immediate benefits to voters while it does not directly confront the wealthy elite who would have to pay for the programs if fair taxes were used to balance budgets. Macroeconomic populism can make everyone happy, for a while, excepting the dour minority that tracks the arithmetic of budgets, balance of payments, and debt.

Of course, only a national economy can run an independent rate of inflation, tied to its currency exchange rate. Mexico has this dubious luxury. But a state or local government can engage in the same sort of fiscal pandering, spending money it does not have to please voters, leaving the resulting fiscal mess to future generations of elected officials and voters. That is the problem Governor Corzine has been grappling with.

There are two reasonable alternatives to the boom-bust cycle of macroeconomic populism. It is necessary either to cut back spending and leave it to market processes to provide jobs and services to the poor or, instead, to combine budget cuts with expansion of the revenue base in order to pay for essential programs with revenues instead of borrowing. Cutting spending and services alone is the conventional conservative remedy. It is also possible, however, to raise revenues and pay for desirable public programs in a responsible way.

A brief examination of Mr. Lopez Obrador's tenure as mayor of Mexico City suggests that he would reinvent the square wheel of macroeconomic populism for Mexico. During his tenure, he initiated massive public spending programs to increase the road capacity of the city. He created many construction jobs by commissioning expensive double-decker highways.

While Mexico City's traffic jams are rightly legendary, Mr. Lopez Obrador's new roadways predictably filled up as fast as they were built. Too, in focusing on private automobile transportation, Mr. Lopez Obrador neglected Mexico City's extensive metro system, which ought to be expanded and spread as the city expands. The problem with public transportation, which Mr. Lopez Obrador chose to evade, is that subway fares are so low that every mile of new track represents a massive operating cost subsidy which could not be met by borrowing. Because he had no real financing program, the public investments Mr. Lopez Obrador did undertake have greatly increased the debt burden of Mexico City residents. Rather than raising new revenue during his tenure, rather than rationalizing the price structure of the metro system - both politically difficult moves that would require courage - Mr. Lopez Obrador chose the easy route of spending a lot of money on projects that would not meet the real needs of his constituents but would make governing Mexico City harder after he left office.

Mr. Corzine came to office on the heels of a succession of governors of both parties who had relied on a "lite" version of macroeconomic populism. They had failed to fund pension programs, they had disguised current spending as capital costs to increase debt finance, and they had generally pandered to the "tax cut and spend" mentality that has proved popular in the United States on the state and local as well as the federal level.

What is notable about Mr. Corzine's efforts is that he has challenged this pattern of macroeconomic irresponsibility. He has done so not with the traditional conservative approach represented by Mr. Lopez Obrador's opponent Felipe Calderon, who advocates cutting both taxes and spending. Rather, while he has indeed cut services and spending, Mr. Corzine has remained committed to retaining essential public services, and to pay for them honestly, through raising taxes. This is a bold move.

As the United States slides toward Latin American standards of income inequality, fiscal irresponsibility, and centralized power, we should recognize the dangers of this trajectory. Macroeconomic populism is the easy way to run up political points among unsophisticated voters, but it bequeaths an economic and political mess to future generations. Only brave and honest leaders can resist the siren song of macroeconomic populism.

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